Dumb is too kind really

I am now back in my normal office after a few days experimenting with a mobile office by the sea. Back in Newcastle I am still only a couple of minutes from the beach but somehow it was different being holed up in a little cabin. Anyway, on the way back down the coast this morning I was bemoaning the idiocy of the human race … again. Or rather cursing the vicarious way the elites exploit the lack of understanding in the community about economic matters to further their own ends. That is a better way of constructing the dilemma. Even some good intentioned souls are proposing “solutions” to non-problems which will worsen the actual problem. Other devious characters are continuing to reinvent themselves in the public sphere – presumably to get access to more personal largesse. Then whole blocks of nations are imposing penury on their citizens to make the “markets” happy while another national government has actually forgotten it is a currency-issuing government. All in a day’s work!

To start things off today, here is a little mid-week (Thursday) quiz. Answer nothing to all questions for a perfect score.

1. Now that we are nearly 3 years into the economic crisis what have policy-makers and the majority of commentators understood about is causes?

2. What have policy-makers and the majority of commentators understood about the fiscal interventions?

3. What have policy-makers and the majority of commentators understood about the likely scenario had these fiscal interventions not been forthcoming?

5. What have policy-makers and the majority of commentators understood about the role that monetary policy played in the current rescue? They think that it was monetary policy that saved the day!

6. What have policy-makers and the majority of commentators understood about the capacities of fiat-issuing governments to deal with major economic crises that manifest as massive collapses in aggregate demand?

7. What do policy-makers and the majority of commentators understand will happen if those capacities are reduced by law?

Several reports over the last 24 hours tell me that the answer to those questions is broadly nothing, in some cases, very little, and in other case sfa. But I will reward the 7 nothing answers with a perfect score anyway!

Further, the failure is not concentrated among conservative ranks. Even so-called progressives are leading the charge to neuter government of their capacities to respond to a major event such as the current crisis. What do they think will happen next time? Answer: they haven’t a clue.

First … US Congressman Chaka Fattah

If you read his proposal for a Debt Free America Act you would think he was a extreme right Republican. Yet, for he parades as a progressive and is a black democrat representing a district in Pennsylvania.

His introduction to the proposal says:

Congressman Fattah has introduced legislation that proposes a bold new approach to eliminating our National Debt. H.R. 4646, the Debt Free America Act outlines how this can be done over the next seven years. The legislation is a dramatic plan that cuts across the usual partisan lines in Congress. It calls for a penny on every dollar on transactions in the United States economy to be directed to eliminating the escalating $12 trillion national debt.

Now I plan to be polite and not just conclude the guy is a loony. His heart is definitely in the right place and he is very concerned about educational opportunities for poor Americans and other noble causes. But what he understands about money systems and the operations of the government he is a part of is limited in the extreme – virtually non-existent would be the accurate summation.

His proposal is prefaced with a litany of humbug statements – all of which are erroneous.

He claims the motivation of the Bill is that the US federal budget deficit is unsustainable. Why? Because China and Greece are going to stop “funding” it. Why? Because they will for the view that the solvency risk on US Treasury debt will become too high.

In turn, this will prompt a “financial crisis of epic proportions” – the dimensions of which are unspecified – and “long-term fiscal stability” has to be implemented – the dimensions of which are specified in The Debt Free America Act.

The plan is to “implement a 1 percent fee on all financial transactions, except for transactions involving stock, as well as retail transactions, which will immediately reduce the size of the national debt.”

The tax would be “charged on all transactions including cash, checks, credit cards, processed through the Federal Reserve Bank, and collected at the point of sale”. The “revenue” would “pay off the nation’s debt within 10 years”.

Apparently, polls show that 87 percent of the American people” want to pay “off the debt” and reduce “the deficit”.

In his Press Release he said:

Interest on the national debt is an extraordinary burden that will crowd out investments on our critical national priorities such as economic development and education … When enacted, the transaction fee I am proposing will generate sufficient revenue to maintain a fiscally responsible budget and allow the federal government to meet its financial obligations while paying down and ultimately eliminating the oversized national debt … The Task Force will, at the same time, change the way we do business in Washington by forcing more responsible fiscal action on our lawmakers and executive branch …

Here are some questions for the concerned Congressman to answer:

1. Exactly, how is the national debt in the US “crowding out investments on our critical national priorities such as economic development and education”? Are the interest payments using up real resources that might otherwise be utilised elsewhere? Are there no real resources idle in the US? Last time I looked that the BLS site they told me there were around 17 per cent of workers without work.

2. What is a “fiscally responsible budget”? Balanced – that is, covered by tax revenue? Is the current US deficit too large or too small relative to the state of aggregate demand in the America? If it is too large then please explain why 17 per cent of US workers are without work and businesses have massive excess capacity not being utilised.

3. What is your understanding of how the US government “meets its financial obligations”? How does that work? And how will collecting a 1 per cent tax change anything with respect to the way the US government spends? Will it increase its capacity to spend? Please explain how a currency-issuing government such as exists in the US needs any revenue in order to spend?

4. Given that aggregate demand has collapsed in the US and the consequences of the recession are going to drag out for some years yet, how is depriving the macroeconomy of trillions of dollars in private spending capacity (via the tax) going to improve things? Please explain how reducing aggregate demand will reduce the budget deficit (and hence reduce national debt)? Please explain how an economy that is starving for spending will grow fast enough to increase employment signficantly if you plan to cut spending?

5. Please provide an analytical explanation of what the term “oversized national debt” means? In relation to what? Please explain how you think restricting fiscal policy with a deflationary tax (at the macro level) will actually reduce national debt fast enough to cope with the rise as the automatic stabilisers drive up the deficit even further?

Someone should ask him those questions in the Congress. Unfortunately, American politics is dominated by deficit terrorists and so no-one will demand such scrutiny.

To see why things will get even worse, not to be outdone, other Democrats (for example, the House Majority Leader Steny Hoyer) has weighed in saying that there also has to be spending cuts to bring down the deficit. And the so-called Blue Dog Coalition (conservative Democrats) have introduced a bill which would require budgets to be balanced.

Please read my blog – Fiscal rules going mad … – for more discussion on why such approaches are self-defeating and dangerous.

Americans seem to have a penchant for quoting historical figures – often inappropriately. Congressman Fattah is no exception it seems:

In my hometown of Philadelphia Benjamin Franklin wisely declared that a penny saved is a penny earned. With the Debt Free America Act, a penny paid will earn massive savings for our nation and families so that our children and grandchildren won’t be saddled tomorrow with yesterday’s debt.

For each individual a penny save is a penny earned. If all individuals increase their saving then the income adjustments downwards will thwart their intentions.

When the private sector increases its saving rate, aggregate demand (spending) falls, inventories accumulate, and firms reduce production levels and employment. If uncertainty increases as the employment growth falters and unemployment starts to rise, then people may try to save even more to increase their security. The problem is that this makes the situation worse – the so-called “paradox of thrift”.

Further, the concept of a nation “saving” when public debt is reduced is nonsensical. The children of the future won’t have to send real goods and services back in time to pay for anything.

Second … Former Clinton hack and Wall Street mogul self-serving to the end

There was an event in New York City on Tuesday, March 2 billed as Robert E. Rubin with Sebastian Mallaby: The Global Economy. It was held at the 92nd Street Y cultural center.

As background you might like to read my blog – Being shamed and disgraced is not enough – on the role that Rubin played in the deregulation of the financial markets in the 1990s and beyond.

Rubin was a senior member (then Chairman) of Citigroup after his political career ended. He left just before its near collapse amidst criticism of his performance. He had pushed Citigroup into increasingly riskier positions (into the sub-prime market) and the bank lost heaps on that debacle.

In 2001, he used a mate in the US Treasury Department to try to put pressure on the bond-rating agencies to avoid downgrading Enron’s debt which was a debtor of Citigroup.

In January 2009, he was named by Marketwatch as one of the “10 most unethical people in business”.

Rubin in cahoots with Greenspan and Rubin’s gofer Larry Summers in undermining attempts by the Commodity Futures Trading Commission in 1998 to regulate the derivatives trade.

This New York Times article from last year – Taking Hard New Look at a Greenspan Legacy – provides a good summary of the events. It documents the fierce opposition that Greenspan, Rubin and Summers put up against any notion of regulation of the financial markets.

Here is a veru good collection of media coverage about Rubin’s latest re-invention of history and his role in it.

This US report – Robert Rubin: ‘Virtually Nobody’ Saw Crisis Coming, Bush Deserves Much Of The Blame – provides a perspective on last Tuesday’s incredible event.

Rubin did not enter into discussion at all about “financial reform or the deregulatory agenda of the 1990s” which he drove.

He claimed that:

Much of the blame for the current crisis falls on the shoulders of the fiscal policy decisions of the Bush administration, Rubin said, under which “we lost a decade to some extent.” The country faces “tremendous headwinds,” Rubin added, including mounting foreclosures, a “paucity of credit” for small- and medium-size enterprises, a jobs crisis, income inequality and declining infrastructure.

First, the die was cast during the Clinton surplus years which Bush inherited by way of a recession in 2001.

Second, the Clinton deregulation agenda and the failure of that Administration to listen to those who were noting the increasing risk exposure in financial markets is a primary reason for the crisis.

Third, the Clinton years also accelerated the gap between US real wages and labour productivity and was the starting point for the rising indebtedness of the household sector.

Rubin and his Wall Street mates helped the process along by financially engineering the indebtedness with a wide array of “new” debt products. They pursued the poor into the sub-prime markets and lied and cheated to ensure that people who were unlikely to be able to pay received funding. They then off-loaded a lot of the exposure onto other funds and investors who were not in a position to know what they were buying.

As it turns out they created and on-sold a time-bomb. Rubin was in the thick of it.

Rubin was also reported as saying that:

President Obama’s failed proposal for a deficit commission was the right idea … the government needs a way to both expand its stimulus program and simultaneously outline a credible long-term plan to reduce the deficit.

As a reminder, the deficit commission was to be an independent body – that is, unelected and therefore not representative – which would have the power to force the US government to introduce major deficit reductions steps after the mid-term elections.

The Senate rejected the Bill in late January, but not because they were enlightened enough to know that it would be a destructive initiative and would undermine the capacity of the US government to reduce its deficit – by stifling economic growth and preventing the automatic stabilisers from reversing over the cycle.

The sensible way forward for the US Government is to introduce large-scale public sector job creation measures which will put purchasing power back into the hands of the unemployed. Unemployment is a highly deflationary state.

The deficit will scale back to an “appropriate level” as economic growth resumes and persists. Anything that endangers economic growth will undermine that process.

The only credible long-term plan to reduce the deficit is one that drives growth now. Discussing fiscal austerity measures and deficit commissions and fiscal rules and all the rest of the misguided hoopla is the anathema of credibility.

For a three-part discussion of fiscal sustainability and what an “appropriate level” deficit is – you might like to read – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3.

For the modern monetary theory (MMT) researchers it was clear that this crisis was going to happen. Rubin was part of the problem that caused it. Perhaps he was blind to it and didn’t see it coming as he is now claiming. That just tells me he has no real understanding of the way the monetary system operates and his views should be completely ignored.

Third … Europe wants to lie down and die

The latest news from Europe tells me that the cold winter is getting to them and they want a quick end for all their citizens. They must be in a state of absolute despair.

Yesterday (March 3, 2010) in the Financial Times I read the headline – Markets pleased by Greek plans.

This of-course is one of the the ultimate perversities of modern human existence. The amorphous “markets” have emotions. And they are pleased when the material standard of living of a nation’s citizens is being decimated by unnecessary policy actions imposed by a cartel of high-wage bureaucrats who face no jobless prospects.

To me – that summarises how our modern existence – dominated by neo-liberal economists – has entered the “failed civilisation” state.

These are the sort of situations that sparked the rise of marxism in the C19th and national socialism in the 1930s. Europe doesn’t seem to learn anything despite its antiquity.

The FT article said that:

The deep retrenchment in public finances, equivalent to 2 per cent of gross domestic product, impressed economists, who saw Athens as having capitulated to pressure from the European Commission and the European Central Bank. Greek bond markets rallied for a fourth consecutive day and the country’s funding costs fell to the lowest levels in a month.

The only economists who would have been impressed by this act of stupidity are those (the majority) who haven’t a clue about how the monetary system operates and fail to realise the real problem in Greece is its membership of the EMU.

The FT article then … as almost an aside … said “(c)oncerns … switched to the effect that the measures were likely to have in deepening Greece’s recession – which, in turn, will make it harder to hit targets for public deficit and debt as a share of GDP.”

Exactly correct. So why impose the obvious on the citizens of Greece? Why set the process up to fail – at which time the bureaucrats and smug economists will demand even more swingeing cuts?

The Greek austerity package plans to cut the “equivalent to almost 10 per cent of GDP over two years” which given the state of the World economy is lunacy.

If the US or Australia did that right now unemployment would go up to beyond 30 or 40 per cent in quick speed.

One “market” commentator, seemingly unable to suppress his joy told the FT that:

The latest budget measures would “dramatically enhance” Greece’s credibility … They would also reinforce “the credibility of the whole European Union framework, for which the Greek case is probably the first significant test”.

Again the perverse idea that amorphous markets are the benchmark by which a nation’s credibility is properly assessed. The only purpose of government is to advance public purpose not the bash the population around with income cuts, unemployment, pension cuts and the rest of it. The fact the Greek government is imposing such austerity on its own people means it has lost all credibility.

Please read my blog – A Greek tragedy … – for more discussion on this point.

And … of-course, Moody’s … was happy. Voila!

But it doesn’t end there.

The bully bosses of the EMU announced yesterday (March 4, 2010) that they were pursuing “a new economic strategy for the next decade” which would see budget rules further tightened.

This apparently is to “reassure Germany’s all-powerful chancellor”. So who won the war?

The news report said that:

The head of the European Commission, the executive that runs the 27-nation European Union bloc on a day-to-day basis, said agreed rules limiting national overspending should be “reinforced and not weakened” on the day Athens announced radical new austerity measures to put its fiscal house in order.

Apparently the German chancellor wrote a letter to the EC which “expressed concern that an emphasis on structural economic reform may lessen the focus on the bloc’s Stability Pact which enshrines fiscal discipline, limiting budget or public deficits to three percent of gross domestic product.”

The response from the EC was that the Stability and Growth Pact (SGP) would not be weakened but made even more stringent. Please read my blog – Fiscal rules going mad … – for more discussion on the SGP.

In my recent book with Joan Muysken – Full Employment abandoned – we said the SGP provides neither stability nor growth.

You can examine EU budget data HERE. The point that emerges is that often the EMU countries (including Germany and France) have violated the EMU rules specified under the SGP.

Rules of this type make no sense at all in isolation of a consideration of movements in other aggregates – such as the external position of each nation and the private saving desires.

But in a crisis of the magnitude the region is enduring now, the rules are meaningless in an operational sense – that is, they cannot possibly be “obeyed” because the movements in the automatic stabilisers alone will swamp them.

So then you get into the current situation – that while the automatic stabilisers are driving the nations into rule violation – which just means the collapse in domestic demand in the economies is very severe and bordering on catastrophic – the bureaucrats (aided and abetted by the “markets”) are forcing pro-cyclical discretionary policy changes onto the suffering nations.

That is absolute madness.

To see how bad things are in the EMU region you can see the latest Key Indicators. Check out the collapse in private spending and the labour market summary. The data is shocking from a macroeconomic perspective.

Yesterday’s news report also said that the new European 2020 strategy would see an:

… embryonic form of “economic government” for Europe …

I perked up and immediately thought that perhaps they were going to introduce a fiscal redistribution capacity to match the single monetary policy unit (the ECB).

But no such luck. Apparently the new “commission” will act as the:

… EU’s legal enforcer … [and] … would acquire powers to issue “recommendations” and “warnings” over countries’ targets in the broad sphere of economic policy, coordinating them with the ultimate goal of shaping Europe-wide results.

They never learn.

Please read my blog – Euro zone’s self-imposed meltdown – for more discussion on this point.

Fourth … the Australian Government forgets it is the government

The Australian Government’s success in intervening early into the recession with a significant fiscal package also was probably a fluke. They clearly do not understand the monetary system they are in charge of. How so?

In the last days, the Government has announced a major policy proposal in the area federal-state relationships with respect to the provision of hospital services and primary health care.

At present, this is largely the responsibility of the states and the standards vary considerably with respect to effective outcomes between states.

The Prime Minister said yesterday that it proposed to revamp the arrangements so that it would take over the responsibility for these services within a unified national hospital and health network plan. It would be funded federally and operated locally – which is a sound principle for any fiat currency system seeking to avoid the inefficiencies of centralisation but gain the benefits of the fiscal power of the currency-issuing government.

As a general principle, MMT would indicate that all public services and programs should be funded centrally and implemented at the spatial scale appropriate to the specific service. For example, someone asked a while back who would be responsible for determining which jobs in a Job Guarantee scheme would be offered. The answer is the communities within which the workers live – they best know what the local needs are.

Anyway, while the details of the health proposals are being debated and there are clear benefits (in my opinion) for this re-organisation (but some costs), the relevant aspect of the discussion so far for this blog is the claim, reported by ABC News today that:

… voters may be forced to pay more taxes to fund the shake-up, which would see the Commonwealth foot the bill for 60 per cent of hospital costs and the full cost of primary health care.

The Health Minister said that the Government would have to cover costs “to implement the plan over the next 10 years”.

The Prime Minister was quoted by the ABC as saying:

Hospital costs are going to go up and therefore let’s just be frank with the Australian people that it’s going to cost more into the long-term future.

The confusion about costs that is reflected in their statements and logic generalises to all government spending. It is also relevant to the health debate in the US at present and the ageing society debate that is being conducted in almost every nation.

The deficit-debt debate continually reflects a misunderstanding as to what constitutes an economic cost. The numbers that appear in budget statements are not costs! The government spends by putting numbers into accounts in the banking system.

The real cost of any program is the extra real resources that the program requires for implementation. So, for example, the real cost of a Job Guarantee is the extra consumption that the formerly unemployed workers can entertain and the extra capital etc that is required to provide equipment for the workers to use in their productive pursuits.

So it might be true that hospital “costs” are going to rise in the future which would mean more real resources are going to be expended in satisfying this policy area – more bits of steel for hip and knee replacements etc. It is also possible, though unlikely, that countries will run out of those real resources and have to “tax” real resources from elsewhere to meet the need should the political process decide.

In poor nations, they already have shortages of these real resources and health care suffers as a consequence.

Government programs have to be appraised by how they use real resources rather than in terms of the nominal $-values involved. A currency-issuing government will always be able to purchase any real resources that are available for sale in that currency. They do not have to “tax” citizens to raise the nominal funds to achieve that.

Such a government can always afford to offer these services under these circumstances.

Two other aspects are important to consider. First, what each historical period offers by way of public services is determined by the balance of the political process. It may be that the younger generations will undermine the capacity of the older generations to deploy real resources in a way that benefits the older citizens. In this case, the government will offer a different array of services and accordingly utilise the real resources available in a different manner.

Second, it is possible that the nominal spending required to satisfy the political demands for better health care will inflate aggregate demand to such a degree that it outstrips the real capacity of the economy to keep up. At that point, the government can use taxation to reduce the nominal demand and avoid inflation. That is, deprive other spenders of some capacity to command real resources. But the tax increases have nothing to do with “covering the costs” of the health reforms.

Conclusion

All these examples, tell us that despite the major crisis that the World economy is still enduring not much has been learned by policy makers and influential commentators about the origin of the crisis, the nature of the solution, or the consequences of imposing even more stringent voluntary restrictions of governments.

It clearly indicates to me that we will have to have a succession of crises before the neo-liberal mainstream in economic thinking is expunged. We need to lesson taught by the fiscal policy intervention to be rehearsed several times it seems before the message will sink into the thick heads.

That is enough for today.

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This Post Has 102 Comments

  1. “When the private sector increases its saving rate, aggregate demand (spending) falls, inventories accumulate, and firms reduce production levels and employment. If uncertainty increases as the employment growth falters and unemployment starts to rise, then people may try to save even more to increase their security. The problem is that this makes the situation worse – the so-called “paradox of thrift”.”

    I’m going to keep trying the wealth/income inequality idea.

    When the few rich who have been experiencing highly positive real earnings growth save and don’t see the need to invest and the many lower and middle class people who have been experiencing slight negative real earnings growth stop going into (or are unable because they are not qualified) debt to the few rich …

    If the lower and middle class stop going into debt to the rich, will the rich get their govt’s to do it for them?

    Thoughts?

  3. “Anyway, on the way back down the coast this morning I was bemoaning the idiocy of the human race … again.”

    I was going to say, Don’t worry, be happy. Have a lobotomy.

    But then I read more.

    Pass the nitrous oxide! With a little helium, please.

  6. We’ve talked about the last mile quite bit here, but I must admit that at times the last mile looks more like the last lightyear.

    The inability or unwillingness of so many to actually examine and understand how our monetary system works is becoming quite disheartening. There are certainly little beams of light that seem to be making their way into the darkness but I must admit falling into pessimism at times (which is not my normal state) about this whole venture we call human existence. Too many blithely act as if the differences we try to illustrate, between what mainstreamers say we “must” do and what MMT says we CAN do operationally, are trivial. I work with a guy who is bright ,a concerned citizen, a fellow eye-roller when the dept. conservatives get on their high horses and someone who looks to question status quo ideas but I am having a terrible time getting him to buy in to much of what we discuss here. He often times answers that its ALL theory and he doesnt know what to believe or that “there is no way the current authorities could misunderstand our monetary system for this long”. This is the one guy at work I really thought would see this paradigm for what it potentially offers but I’m struggling with him. I’m sure part of it is my weakness in relaying the info but I send him articles from here all the time (and he says he reads them). My point in bringing this up is that it is difficult to unseat notions about things you’ve held for a long time, especially when your notions seem to have “worked” for so long. There must be many people, me being one, that really never hold too tightly to ANY notion. We are always in a provisional state of knowing and refrain from believing we’ve figured anything out. I think that might be why MMT rang so true for me because it was not about “believing” anything in particular but simply understanding some human construct on an operational level. I think on a certain level, the ideas we are trying to overturn, have placed themselves amongst the “natural” things in the minds of many. They fail to see what we have as “constructed”. They see it as “discovered”. They see this as Einstein saw E=mc2, something which is at the heart of our existence. Money is “natural” not a state created thing and only our state efforts poison it and bring on hyperinflation.

    I know Im waxing philosophic here but I really do wonder what it is about people that allows them to see an obvious clusterphuck, that is our current monetary/economic system, and simply attribute naturalness to some of it and intervention to other parts. The WHOLE THING is man made. MONEY is an invention. A useful invention but an invention none the less and too many refuse to see it as such.

  7. Democrats, since Reagan era, have never been able to meld politics with economics in a way that helps their constituents. They still live in fear of the Reagan’s shadow. Robert Rubin, Hamilton Project, DLC and Blue Dogs are examples of that.

    Instead of ripping the hell out of Reagan’s flawed and failed ideology they find ways to “moderate” it. But it still has the same flawed foundation. Unfortunately, for us, Obama is not much different than Robert Rubin and Hamilton Project partners.

  8. Greg: “He often times answers that its ALL theory and he doesnt know what to believe or that “there is no way the current authorities could misunderstand our monetary system for this long”.”

    For one thing, in many ways, at least in the U. S., we have acted as though we were on a Gold Standard. We do borrow an amount equal to the deficit. That very fact obscures the argument about the gov’t spending before it borrows, as it comes to the same thing in the end. True, we do not peg the dollar to gold, and the price of gold fluctuates. But to many the rising price of gold just represents a secret debasement of our currency.

    Consider this from Hilary Clinton: “I served on the budget committee in the Senate, and I remember as vividly as if it were yesterday when we had a hearing in which Alan Greenspan came and justified increasing spending and cutting taxes, saying that we didn’t really need to pay down the debt – outrageous in my view,” she said.

    “We have to address this deficit and the debt of the United States as a matter of national security not only as a matter of economics,” Clinton said. “I do not like to be in a position where the United States is a debtor nation to the extent that we are.”

    It is not entirely obvious at first glance that she is not disagreeing that we do not need to pay down the debt, she just finds the idea outrageous. At the same time, she does not want to owe money to foreign governments.

    Now, if we stopped selling treasuries we would owe less and less to foreign governments and everybody else, as the debt expires over time. I do not know if she would find that outrageous or not. Bill Clinton made some remarks recently on CSPAN that indicated that Rubin put the fear of the bond market in him when he was President.

    Moi, I think that many political leaders do understand that we are not bound by the Gold Standard, but they recoil from that just as they recoil from the idea that without God everything is permitted in “The Brothers Karamazov”.

  9. Greg: I hope it’s not really a light year but regardless we should all do our bit to advance MMT and the opportunities it makes possible. Good luck with your colleague! Perhaps another crisis or two will be required but let’s hope not. I continue to believe that the prevalence and intuitive appeal of household logic is the hurdle to explaining the issues. Household logic appears to be simple common sense, it is everywhere and easily understood. We need to find a way to overcome it but I haven’t seen anything yet that does it nor have I figured out how to do it myself.

    RebelC: James Galbraith’s book Predator State covers the topic of your comments in way that is consistent with MMT. I strongly recommend it.

  10. Dear Bill,

    The Neo-Liberal extremists are absolutely everywhere. As the worlds oldest BMX enthusiast (not really but at 40 it feels like I am) I go to BMX sites. These sites contain people who never and I repeat never post videos of themselves riding, nor do they post pics of their bikes, nor do they ever attend meetings or get togethers with other riders. In fact I have serious doubts that these pricks even ride.

    What they are actually doing is pretending to be kids on sites and infecting the youngsters on them with their neo-liberal bullshit. It’s a disgrace.

    Go to other sites be it for music, for hi-fi, for cars, for anything in fact and the Neo-liberals are out there recruiting for their army of fools.

    MMT advocates seem to restrict themselves to economically orientated sites. Perhaps your lot need to fight dirty to make up some ground.

    Cheers, Alan.

  11. I still don’t understand why MMT authors all claim budget surpluses during the Clinton years are the primary cause of the acceleration in private sector debt (which kept building up to this crisis) and the recession in the early 2000s. You claim elsewhere to build off the work of Minsky, yet ignore the “stability breeds instability” angle. I think this hurts your larger case, the majority of which I agree with.

    For example, Bill said above “First, the die was cast during the Clinton surplus years which Bush inherited by way of a recession in 2001.” And here: “…the budget surpluses of the late 1990s not only squeezed the private sector and helped start the private debt-binge but also led to the recession in the early 2000s…”

    Please provide or link to more evidence of this reasoning. As I see it here are the factors in play:

    1. Tax changes in 1993 supposedly “raised taxes on the wealthiest 1.2% of taxpayers, while cutting taxes on 15 million low-income families”. One of the major changes was an increase in the top marginal rates.

    2. Economy booms in mid to late 1990s and bubble mentality forms.

    3. Many assume the “good times” (strong current and future income prospects, stock markets rising forever) will never end and take on debt to consume more than they “need” (e.g., the SUV craze).

    4. Some with low incomes *are* squeezed financially by the wealth and income concentrating effects of technology and globalization, and must take on more debt for basic living, but this is not a result of government surplus.

    5. Rising incomes and capital gains cause tax receipts to rise and push the government budget temporarily into surplus (especially as more incomes hit the higher marginal brackets). Note that direct government spending never dropped year-to-year.

    6. Stock bubble and “new economy means rising income forever” bubbles burst leaving the debt behind.

    So why would the preferable response of government here have been to avoid running a surplus (cutting taxes or raising spending), or do you disagree with this list of factors?

    I see an argument for government pushing for better distribution of income WITHIN the private sector (via taxation and transfer payments) to reduce issue #4 above, but that need not have had any impact on the SECTOR-WIDE government surplus. A lot of tax money collected in the top marginal brackets is money that wouldn’t have been spent (contributed to GDP) at all if it hadn’t been taxed.

    In this post I do for the first time see Bill elaborating a little more beyond focusing on just the overall government surplus: “Third, the Clinton years also accelerated the gap between US real wages and labour productivity and was the starting point for the rising indebtedness of the household sector.” Which seems logical and more on track than blaming the surplus.

    Look at this chart of year-on-year changes in balance sheet wealth in the US. Why should a government surplus (green line) of around $119bn in 1999 and $219bn in 2000 be to blame for allegedly being so harmful? (I realize changes in government deficit have a much greater effect on incomes than changes in tangible asset values or stock market values, but the latter effects dwarf the government deficit by a factor of ten or more in that graph).

    I’m happy to be corrected if I have this wrong but am trying to address the MMT issues that bother me.

  12. Also in my ongoing quest to examine theory in the light of real world data, I’ve been looking at the national accounts balance sheet data for Japan and the US. MMT authors don’t talk much about tangible assets (focusing on financial assets), but some might be interested to see their relative magnitudes graphed:

    Balance Sheet Wealth in the US and Japan; Historical Data in the Context of Modern Monetary Theory

    In particular I think this chart of total wealth in Japan (tangible assets plus net government liabilities, plus stock market valuation if you think it relevant) nicely shows how government deficits have sustained (in rough terms) the level of private sector wealth. (I know income effects matter too and they are not shown here).

  14. Bill, Thought Offerings wonders about MMT and equities are financial assets here:

    However, there are a few areas I still find myself disagreeing with MMT on (subject to change as I learn more!) and one is the treatment of equities/shares (in the stock market sense). In short, when the market bids up stock prices, owners of those stocks feel wealthier, but the corporations to which those shares are a liability do not act correspondingly poorer or reduce their propensity to invest or generate revenue in any way.

    I was also wondering about the accounting. Corporations carry shareholders equity at book value, which is usually differs from market value. How does MMT handle changes in market value the equity markets? Does this affect nongovernment net financial assets? It certainly has an impact on the wealth effect, for example.

  15. Fed Up If the lower and middle class stop going into debt to the rich, will the rich get their govt’s to do it for them?

    That’s what the bailout is all about. Instead of letting the debt go bad as per capitalism, the government step in to prop it up. This is now commonly known as “socialism for the rich.” It has a lot to do with the current populist outrage.

  16. Hi Tom,

    JKH did a nice explanation of equity claims on comment 188 here that is consistent with how I see them and also how Godley/Lavoie treat them in their book . . . http://www.debtdeflation.com/blogs/2009/09/27/it%e2%80%99s-hard-being-a-bear-part-sixgood-alternative-theory/?cp=all

    I would add also that the argument about bid up prices of shares not making corporations feel poorer is a particularly bad argument, as the exact same could be said for bidding up the market price of a company’s debt.

    Regarding book value vs. market value, I could use either depending on the purpose. You have to be careful with misusing either one–for instance, the argument that households didn’t have to worry about adding to their debt in the late 1990s because the market value of the portion of their financial assets that held as stocks was growing even faster. By the same token, if the Fed were to undertake a large scale effort to permanently raise the price of Treasuries, then a market value analysis could be useful, as NFA for the non-govt sector would be increased (as an aside, this is the monetarist view of the transmission of monetary expansion, but from an MMT perspective, it’s effect is actually via an increase in NFA).

  17. I would also like to see some response to hbl’s points at 3:46 and in the earlier IMF post. Recently I’ve had the financial sector balances discussion with several supporters of the Clinton era economic policies (including the surplus) who are quite savvy and very convincing and I’ve come away feeling very uneasy about MMT claims that the late 90’s surpluses were the determining factor in causing the early 00’s recession. If a separate post with hard numbers to illustrate the sectoral balances would be possible I feel that would go a long way to addressing any concerns out there. There is no rush though. I know I mentioned these concerns earlier so I just want to be sure I don’t come off as pushy or demanding.

  18. Hi NKlein

    You might check out any number of pieces at http://www.levy.org published in the late 1990s or in 2000 predicting the recession via a sector financial balances approach. Of particular interest would be the various Strategic Analysis publications, or a number of pieces by Randy Wray. As Randy has noted more recently, they actually forecasted a much worse recession in the early 2000s than happened because they didn’t realize in the 1990s that such a big correction would be cut short by starting another bubble in housing (and also the strong reversal of the govt’s financial balance via automatic stabilizers (which was predicted) and the Bush tax cuts). The size of the correction we have now is at least in part due to the fact that there wasn’t a complete correction then.

    Best,
    Scott

  19. Tom Hickey,

    Thanks for seconding my question… I’ve done some google searches across Bill’s blog and can’t find any place where he has addressed stock market valuation. It is my opinion so far that MMT’s focus on net financial equity, while critical in understanding the vertical role of government, misses the real world behavioral and economic implications of horizontal transactions. To elaborate:

    1. A household or business incurring debt (loan or bond) doesn’t change the non-government sector’s net equity, but it DOES change the sector’s propensity to consume, even if only slightly. The borrower is likely to spend the new money, but also to reduce future consumption in order to service the loan (and likely to pay down principle). So in this case saying net equity is unchanged is sort of (but not exactly) aligned with the actual wealth effect that results from the transaction.

    2. A household buying into a new share offering by a business is more problematic… The household’s net equity is unchanged (bank deposits now replaced by corporate shares). The business has expanded its assets (additional bank deposits) and its liabilities (additional paid in capital). But are these liabilities are in perpetuity, never having to be paid back or paid interest on (unless the company chooses to pay dividends), so they act more like an increase in net equity. This site is a good guide to the accounting.

    3. When the market bids up the public company shares held by the household, the household share asset is always marked to market, increasing household balance sheet equity. In the real world, the corporate balance sheet never changes as a result. Wikipedia: “In the stock market, market price per share does not correspond to the equity per share calculated in the accounting statements. Stock valuations, often much higher, are based on other considerations related to the business’ operating cashflow, profits and future prospects; some factors are derived from the accounting statements. Thus, there is little or no correlation between the equity seen in financial statements and the stock valuation of the business.”

    So this is one area I think that MMT theory does not seem to reflect reality (in the same way that neoclassical economists model the economy as an aggregation of rational agents, even if not so damaging!) But I still think the core policy implications of MMT are right on since they relate more to the vertical.

  20. Love the site, analysis and comments (you know a site is good when the comments are germane). From Ireland. Govt took billions of €’s out of the economy in the form of public service pay cuts, pensions cuts, dole cuts + wave of pvt employees replaced by agency workers at minimum wage rates (yeese get the idea). Guess what? January tax receipts crashed yet again below projections. After two systemic budget cuts, the tax receipts keep tanking. The mainstream concensus. We need more cuts (except for bankers and top civil servants who don’t have to take wage cuts)! And the international bond market is happy with Ireland.

    One day we shall be able to compete with China on a level wage scale, and generous tax incentives for Multinationals. In the meantime, say hello to all the Irish immigrants for me.

    slán

  21. Scott F,

    I didn’t see your reply to Tom when writing my last comment, but…

    “JKH did a nice explanation of equity claims on comment 188 here that is consistent with how I see them and also how Godley/Lavoie treat them in their book”

    JKH says “The point is that even though common stock is not categorized as a balance sheet liability, it is a financial claim issued by the corporate sector and a financial asset held in this case by the household sector. Common stock and equity claims in general are treated as a financial asset of the holder and a financial obligation of the issuer (cash flow and marked to market evaluated), and because of that essentially net to zero when consolidating the net financial asset position of the non government sector.”

    “are treated as” refers to a convention adopted by MMT but doesn’t explain why it is relevant to the real world economic effects of horizontal transactions. Also I have the Godley/Lavoie book (though I haven’t gotten to do more than skim it yet) and it acknowledges on page 28: “With balance sheets evaluated at market prices, the bond will be entered as a $120 claim in the balance sheets of both the holder and the issuer of the bond, although the corporation or the government still look upon the bond as a $100 liability.“

    “I would add also that the argument about bid up prices of shares not making corporations feel poorer is a particularly bad argument, as the exact same could be said for bidding up the market price of a company’s debt.”

    Yes, the same could be said but I didn’t say it in order to be more concise. That makes the argument incomplete, not automatically a bad argument. It may be a bad argument but you haven’t said why it is.

    “Regarding book value vs. market value, I could use either depending on the purpose. You have to be careful with misusing either one…”

    I’m not clear on your position based on this paragraph. If the purpose is to understand how horizontal transactions impact economic activity, which would you use? And would you insist on using the same (book or market) on BOTH the asset and liability side? If so, why precisely?

  22. Hi HBL,

    “1. A household or business incurring debt (loan or bond) doesn’t change the non-government sector’s net equity, but it DOES change the sector’s propensity to consume, even if only slightly. The borrower is likely to spend the new money, but also to reduce future consumption in order to service the loan (and likely to pay down principle). So in this case saying net equity is unchanged is sort of (but not exactly) aligned with the actual wealth effect that results from the transaction.”

    Agreed. How is that inconsistent with MMT? MMT is about the accounting, but you’re talking about behavioral equations for determining key entries in the financial statements. Not the same things, and totally complementary as well.

    “2. A household buying into a new share offering by a business is more problematic… The household’s net equity is unchanged (bank deposits now replaced by corporate shares). The business has expanded its assets (additional bank deposits) and its liabilities (additional paid in capital). But are these liabilities are in perpetuity, never having to be paid back or paid interest on (unless the company chooses to pay dividends), so they act more like an increase in net equity. This site is a good guide to the accounting.”

    Again, not a problem for MMT. See my link to JKH’s comment at 6:02.

    “3. When the market bids up the public company shares held by the household, the household share asset is always marked to market, increasing household balance sheet equity. In the real world, the corporate balance sheet never changes as a result. Wikipedia: “In the stock market, market price per share does not correspond to the equity per share calculated in the accounting statements. Stock valuations, often much higher, are based on other considerations related to the business’ operating cashflow, profits and future prospects; some factors are derived from the accounting statements. Thus, there is little or no correlation between the equity seen in financial statements and the stock valuation of the business.”‘

    Again, not a problem for MMT. The household’s NFA has increased, and the company’s has decreased (using the more common accounting understanding as described by JKH in the comment I linked to).

    “So this is one area I think that MMT theory does not seem to reflect reality (in the same way that neoclassical economists model the economy as an aggregation of rational agents, even if not so damaging!).”

    I respectfully disagree completely. It’s only if you think accounting can’t reflect an accurate tracking of transactions that you could possibly be correct. MMT is perfectly consistent with accounting . . .indeed, if MMT disagrees with accounting ever, we need to adjust MMT. Your points here are inconsistent with actual accounting practice, and that’s what’s leading you astray.

    Best,
    Scott

  23. “Yes, the same could be said but I didn’t say it in order to be more concise. That makes the argument incomplete, not automatically a bad argument. It may be a bad argument but you haven’t said why it is.”

    It’s a bad argument because the opposite is true. It is when prices of debt or equity are bid down that companies feel poorer, as it’s more difficult for them to raise more funds, and they may be in violation of some covenants (for debt, anyway). And note that the exact same is true for those who hold the debt or equity as financial assets.

  24. Scott F, thanks for your responses!

    “Your points here are inconsistent with actual accounting practice, and that’s what’s leading you astray.”

    If that’s true I’d love to correct my understanding and would appreciate any pointers to accounting books or online resources to clear things up. I quoted the wikipedia link above and here is another quote: “Since the asset amounts report the cost of the assets at the time of the transaction-or less-they do not reflect current fair market values. (For example, computers which had a cost of $100,000 two years ago may now have a book value of $60,000. However, the current value of the computers might be just $35,000. An office building purchased by the company 15 years ago at a cost of $400,000 may now have a book value of $200,000. However, the current value of the building might be $900,000.) Since the assets are not reported on the balance sheet at their current fair market value, owner’s equity appearing on the balance sheet is not an indication of the fair market value of the company.”

    Both these sources leave me with the impression that “actual” accounting involves the market value of equities being used by those who hold them as assets but not those who hold them as liabilities. Bonds may be somewhere in between as I understand that when a company’s bond prices increase or decrease the change is sometimes reflected on the income statement and balance sheet, so that’s why I was focusing on equities.

    “It’s a bad argument because the opposite is true…”

    Again that just makes it an incomplete argument. The fact that falling market prices also impact the holder of the asset logically follows from the case of them rising. However you did introduce a new response with “It is when prices of debt or equity are bid down that companies feel poorer, as it’s more difficult for them to raise more funds, and they may be in violation of some covenants (for debt, anyway)”. I’ll ponder that as it seems like a relevant consideration, though it still doesn’t change my understanding (so far) of the “actual accounting”.

  25. Hi HBL,

    “Both these sources leave me with the impression that “actual” accounting involves the market value of equities being used by those who hold them as assets but not those who hold them as liabilities. Bonds may be somewhere in between as I understand that when a company’s bond prices increase or decrease the change is sometimes reflected on the income statement and balance sheet, so that’s why I was focusing on equities.”

    OK, I see where you’re going now with this. The problem is that you can’t compare a book value for the company’s stock issuance and a market value for a household holding the stock as an asset from the macro perspective and say that NFA have been created. You’re comparing apples to oranges. If the company wants to buy back its own stock and take the company private and thereby eliminate both the household’s asset and the household’s claim on its own equity on its balance sheet, they can’t purchase the stock back at book value, they have to purchase it at market value. Aggregate accounting for the macroeconomy that we are doing is about these offsetting relationships. If you’re going to use book values, you have to use them all the way through. If you’re going to use market values, again, you have to use them all the way for everyone or every sector. As I explained at 6:02 above (and gave examples), sometimes BV is more appropriate, sometimes MV is. It depends on what you’re studying. There’s no hard and fast rule that you always have to use one or the other; what matters is that you’re consistent at the macro level and that the measure (BV or MV) is appropriate for the issue you’re looking at.

    It’s the same in financial analysis at the micro level. If I’m valuing a company and need a measure of a company’s operating capital for estimating free cash flows or returns to capital, I use book values of equity and debt. If I’m trying to determine the company’s relative weights for its costs of equity and debt in getting a cost of capital for the company, I use market values. There’s no inconsistency, I’m just applying the appropriate measure (MV or BV) consistently to the issue I’m investigating; financial analysis sometimes calls for BV, and sometimes it calls for MV.

    It’s a bit like nominal versus real variables. You can’t compare real GDP of one country or state to the nominal of another. And whether you use real or nominal depends on what you’re studying. There’s no hard and fast rule that says you always have to use one or the other, only that the one you are using is appropriate for the issue you are studying and that you’ve applied it consistently.

    “Again that just makes it an incomplete argument”

    If the opposite point is true, seems to me the argument is false, not incomplete, but whatever . . . not that big of a deal for the overarching issue here, it appears.

    Best,
    Scott

  26. Scott, thanks for the recommendation. Looking through the Levy Institute website I see the strategic analysis section goes back to January 1999, “Seven Unsustainable Processes.” I guess I’ll start there.

    Also, wow, JKH’s comment 188 over at the debt deflation website is really fantastic. Very understandable even from the perspective of someone like me who has never studied any accounting at all. This summer I’m going to have to pick up an accounting textbook for myself so I can better follow some of the discussion that goes on here. As an aside, I was just wondering if anyone knows where JKH gets his/her numbers for total assets/liabilities from? I suppose their is a database somewhere that keeps track of such things.

  27. Hi Scott F.,

    “If the opposite point is true, seems to me the argument is false, not incomplete, but whatever”

    I didn’t requote your whole paragraph but when you said “opposite” the logic in your paragraph (as I understood it) implied you had actually meant to say “reverse”.

    “financial analysis sometimes calls for BV, and sometimes it calls for MV.”

    Thanks for the details, and that is logical. However that choice is for the share issuer, not the share holder. The share holder ALWAYS uses market value. So by this logic, when the issuer (company) is using market value, then no net financial assets would have been created by the share issuance. However, when the issuer is using book value, that implies the private sector has created net financial assets. And that latter case seems to be the default accounting scenario in the “real world” from everything I’ve read (unless you are addressing special scenarios like the examples you gave).

    “If the company wants to buy back its own stock and take the company private and thereby eliminate both the household’s asset and the household’s claim on its own equity on its balance sheet, they can’t purchase the stock back at book value, they have to purchase it at market value.”

    Yes but that it a optional subsequent operation that it is in no way inevitable (and not even that common). That’s sort of (though not exactly) like saying that if the government deficit spends we should ignore the increased net financial equity in the private sector when looking at the accounting implications because the government has the option to raise taxes in the future and remove that net financial equity. It seems to me that the accounting should be based on current actuals not future hypotheticals.

    Also I read pages 27-31 of the Godley/Lavoie book more carefully. It says:

    “The current stock market value of the stock of equities which have been issued in the past shall be assessed as being part of the liabilities of the firms. By doing so, as will be clear in the next subsection, we make sure that a financial claim is equally valued whether it appears among the assets of the households or whether it appears on the liability side of the balance sheet of firms.”

    and

    “In the present book, balance sheets at market prices will be the rule.”

    and especially on page 30

    “Obviously, accounting at historical cost in the case of the producing firms would make the whole macroeconomic accounting exercise incoherent. In particular, the macroeconomic balance sheet matrix, to be developed below, would not balance out… Another way out, which national accountants seem to support, is to exclude the market value of issued shares from the liabilities of the firms. This is the approach taken by the staticians at the Federal Reserve…”

    So forgive me for thinking that the simplifying assumptions for the sake of balancing out a textbook matrix sound analogous to Bernanke saying “I do not deny the possible importance of irrationality in economic life; however it seems that the best research strategy is to push the rationality postulate as far as it will go.” (Not that MMT ignores irrationality, it’s a comment on the use of “elegant” simplifying assumptions).

    I hope this doesn’t sound hostile as I have great respect for MMT and its insights, especially regarding the vertical, and I wouldn’t consider this a core issue. And maybe I’m wrong to contest this, I am still learning!

  28. Hi HBL

    The G/L quotes are EXACTLY as I’ve been saying. They’ve made a choice of market values only, because it fits their purposes. And they note that using book values for companies and market values for households would make no sense in the aggregate.

    Best,
    Scott

  29. Returning to the Greek problem. 1. Balance of payments deficit. 2. Private budget surplus (profits spent on imports, capital outflow, domestic savings deposits privacy protected and real estate purchases at undereported prices). 3. Private debt less than GDP.4. Unreported GDP near 40% of reported GDP. 5. Private productive investment practically nil. The result is public deficit to support GDP and public debt higher than reported GDP, mostly owned by foreign funds. Austerity program implemented to satisfy foreign funds holding maturing debt to be renewed at higher spreads at the expense of GDP which will decline from both effects, leading to a crisis spiral and a crash.

  30. Postcript to previous comment on Greece. The Greek Government instead of being concerned with a credibility problem it has with the EU and foreign funds it should focus on gaining credibility with its own citizens who have lost faith in their economy and society. This is the way to solve the Greek problem, otherwise let the last person out turn the lights off. As about the EU it has a much bigger problem than Greece with the euro and the possibility of default on the public debt of the Southern States and Ireland induced by the austerity measures implemented.

  31. Scott,

    My point with the G/L quotes was that they acknowledge that they use market values for liabilities because it fits their purposes (helping matrixes balance) and they further acknowledge that this approach doesn’t reflect real world accounting (as used by national accountants) or intuitive economic reality (I didn’t quote that part but they give a few examples). I didn’t see the part where they “note that using book values for companies and market values for households would make no sense in the aggregate”, but perhaps I overlooked it.

    It reminds me of the joke about the chemist, physicist, and economic on a desert island…

    Anyway, I really appreciate you taking the time to discuss this.

  32. Why does everyone have to get so technical? The average person on the street wouldn’t be able to make heads or tails of what’s being written here.

    I thought the idea was to educate the masses rather than to further exclude them ?

  33. HBL . . . as I’ve said repeatedly here, there’s no hard and fast rule that says you have to do accounting (balance sheets in particular) always with MV or BV. Depending on the context, one or the other may be more appropriate. I can think of instances where I would be doing MMT research and I would choose to use MV, and I can think of instances in which I would choose to use BV. It is definitely the case that non-financial corporations generally report their balance sheets at BV, but that doesn’t mean that someone doing analysis would never use MV. In fact, MV is done frequently for official balance sheets of financial institutions (recall the controversy over mark-to-market accounting). G/L are simply explaining that MV fits their context better even though most are probably used to seeing corporate balance sheets with BV. I really don’t see why this is such a big deal.

  34. Dear Scott,
    can you explain the difference between MV and BV, please?
    Thanks
    Graham

  35. Hi Graham

    MV is market value, which means entering items on the balance sheet at their market values. Godley/Lavoie are using this approach, and it matters particularly for equities . . . a household holding stocks will see its assets rise/fall with market values in their models, and a corporation will see its equity accounts do the same. I think that’s entirely appropriate for their purposes.

    BV is book value, which means entering items on the balance sheet at the price they were purchased originally. In that case, a company’s equity accounts will not rise/fall with changes in the market price of their stock, but are set when they issue the equity and don’t change unless they are repurchased. A household holding stocks would not see its assets rise/fall with market values, but would rather be fixed at the price the household purchased the stocks at until the stocks were sold.

    It is common practice to use BV for non-financial corporation balance sheets, at least those officially filed. It is common practice for economists to consider MV for households. This is not to say that there is no MV accounting for non-financial corporations, as the statement of cash flows is generally done with MV, and these link balance sheets and income statements.

    If you are going to do an aggregate model of the economy or some subsector of the economy and make it stock-flow consistent as G/L do and as MMT’ers prefer, then you will have to choose whether you use MV or BV throughout, as mixing MV and BV makes about as much sense as comparing real and nominal (that is, no sense at all). G/L recognize this, and in their case, as I noted, MV is entirely appropriate for what they are trying to accomplish. On the other hand, if I am modeling transactions between the Fed, the Treasury, and banks, as I have frequently done, BV can be entirely approrpriate in many instances (though MV could be appropriate, too).

    Hope that helps.

    Best,
    Scott

  36. Hi Scott,

    I thought the controversy over mark-to-market accounting was about valuation of assets and had nothing to do with the liability side (though perhaps I am incorrect).

    In your response to Graham I think I see one of the main things I’m having trouble with… your comment that “mixing MV and BV makes about as much sense as comparing real and nominal (that is, no sense at all)”. My understanding was that a share asset and a share liability are inherently different (I quoted a couple accounting resources above that I interpreted this way). For example the market values the share asset to include an estimated value of future earnings, and I assumed it usually made no sense for the share liability to price in anything other than present book value. Plus I thought G/L were confirming that national accountants value the asset and liability side differently (mixing MV and BV) also. But I think we’re reiterating the same points now and I’m outside my expertise so I’ll let it drop.

  37. Hi Hbl

    The point is that IF you are going to do an AGGREGATE model like G/L do, you MUST choose between MV or BV and stick with it throughout. That assets of some are sometimes or even regularly published in BV and liabilities of others are sometimes or even regularly in MV, in specifici instances unrelated to trying to blend these into a model, is IRRELEVANT to G/L’s purposes and IRRELEVANT to any stock-flow consistent modeling approach like MMT prefers. What is needed in that case is a coherent way to account for ALL the transactions in the system you are modeling, and for that you CANNOT blend MV and BV.

    Best,
    Scott

  39. Hi HBL,

    Let me try one more thing here.

    You’re talking about the fact that sometimes the assets and issued liabilities of an entity may be accounted for differently. Yes, that does happen, particularly with some financial institutions. It’s not uncontroversial, but it happens. Of course, if you mark the asset side to market, then the total value of equity is also effectively marked to market, since a serious decline in the value of assets can leave a company with no equity left, but that’s another story.

    What I’m saying is that you can’t put together a model incorporating transactsion between companies and households and then use BV to account for the issued liabilities of companies on company balance sheets, and use MV to account for these same items held as assets by households. That will be a completely incoherent model. G/L recognize this, and point out that even though most may be more familiar with BV accounting for companies, they are going to use MV for everyone in order to be coherent and because it fits their purposes.

    Hope that helps.

    Best,
    Scott

  40. Scott, thanks for trying, but I think we’re still stuck, and this medium seems challenging for clearing up this kind of discussion…

    “You’re talking about the fact that sometimes the assets and issued liabilities of an entity may be accounted for differently.” Actually I haven’t intentionally brought up the topic of the assets of a corporation at all, just share assets held by a household.

    “That will be a completely incoherent model.” Perhaps the model would be “incoherent”, but the real question is to what extent the model reflects (1) real-world accounting (not just model accounting), and (2) the thinking (and therefore behavior) of participants in said real world (corporate decision makers, stock holders, etc). I expect that you would respond that it reflects both, but that is what I remain unconvinced of, and I may need a degree in accounting to make further progress now 🙂

  41. “Friday, March 5, 2010 at 13:23
    Why does everyone have to get so technical? The average person on the street wouldn’t be able to make heads or tails of what’s being written here.

    I thought the idea was to educate the masses rather than to further exclude them ?

    Alan has a point here.

    I was once a regular commentor on this blog, knowing nothing at all about economics and having stumbled across the site by chance. Only a few of the people who comment now were here then (Alan being one of them). Through straightforward discussion of each topic, I was able to put together a basic understanding of how the mechanics of the thing we often choose to call “money” function in regards to the big picture and how completely different a modern day fiat-currency system is to the gold-standard type systems that preceeded it.

    Just as a mechanic could in a fairly short space of time, educate you as to the very basics of the systems that combine to produce a running car and to how a modern, computerised car engine is different to the older models that are no longer produced, without delving into a million points of technical minutae.

    Increasingly however, more and more people came here who obviously have formal economic and financial training and naturally speak in technical terms and the discussions are often concerned with “micro-functions of the engine”. I guess this is a natural evolution for a blog such as this one but it does leave me feeling that I have little to contribute to the discussion often times.

    On the upside, as I surf the blogosphere, I notice that the ideas put forward by Bill Mitchell, Randy Wray, Warren Mosler and others are beginning to show up and be discussed more and more widely. This is a good thing and the message does seem to be getting out there, but we should remember that it won’t happen overnight if history is any guide. It took around 25 years, a great depression and a world war before Keynes’ ideas became broadly accepted so we should probably expect many countries to punish their people with high unemployment, social instability and relapses into weak and floundering growth for years to come.

    Because they believe that they “have no choice”.

    For myself, I will continue discussing these ideas with people so that they begin to question what they assumed was logical, factual commonsense.

  42. Alan, I disagree. Most of the discussion here is aimed about right, and there should be opportunity for deeper questions, too. It’s great that we have people that are both able and willing to field them. There isn’t any other place I know of that one can do this and get an answer in terms of solid MMT-based analysis. I think it contributes greatly to the blog community here and I feel comfortable sending both rank beginners and economists here. I would assume that people only read the comments that address topics of interest to them. It took me awhile to get up to speed and there’s still a lot have to go over and terminology that I have to google. But little by little, I am getting it, thanks to Bill and everyone else.

  43. Hi Tom,

    I assure you that the discussion has become rather more technical over time.

  44. Lefty and Alan,

    Would you prefer that we ignored the technical questions? How does it help further MMT if we don’t demonstrate that MMT is robust at a very technical and sophisticated level of analysis to those who ask such quesitons and have reservations that can only be dealt with at that level? Or perhaps you’d prefer that we banned such questions? I’m not seeing your point, in other words, at least in terms of the overarching goal of furthering MMT, besides the fact that you don’t appear to like reading those discussions. But there are a lot of discussions that occur on this blog that I’m not interested in, either, and I just skim over them and let others go about their business if that’s what they prefer.

    Best,
    Scott

  45. Lefty, I agree. That likely shows that more economically astute people are showing up. But here’s still plenty of space for relative beginners to ask questions as far as I can see, and some of us who were beginners not long ago can help out and take some of the burden off those more advanced, where they aren’t actually needed. An MMT economist isn’t required to answer every question, but when one is needed, there is someone here who steps up. That’s a great advantage of this blog. Plus, there are usually several different threads in play in a single post here, pitched at different levels.

  47. HBL . . yes, we’d probably solve this in short order if we could just talk over a few drinks. And we could keep talking thereafter, as there’s no sense stopping after only a few.

    Best,
    Scott

  49. Hi Scott,

    No I would not prefer it that Bill banned such questions. Perhaps you would point to where I have insinuated this?

    You seem slightly offended by my comment but I am simply agreeing with Alan that the discussion of the articles is often so technical that a layperson would be completely bamboozled. I am not questioning the need for MMT to be sophisticated, merely pointing out that the layperson would not be able to differentiate between much of the discussion here and technical discussion on any other school of economic thought, be it Austrian, neo-liberal or anything else.

    As I have previously stated, I believe this is because the number of already economically/financially trained people here now outweighs the number of those who have no such training.

    It is an observation, plain and simple.

  50. Dear Lefty

    I try to keep my blogs as simple (in analytical terms) as I can. I really want the blog to be inclusive so that every level of background can be brought into the debates and issues.

    I cannot control the commentary though (other than to delete those which do not accord with the comments policy). That is not to say I don’t enjoy the more “technical” input from the commentators.

    They are very valuable when dealing with economists who think we are just a bunch of bleeding heart lefties who don’t have dynamic models or rigourous analysis.

    So I actually see a balance between the two emerging in the comments which I am grateful that people take the time to contribute to the community here.

    At any rate, I hope you keep providing your excellent insights when you feel it is appropriate – your were one of the first to provide input and I appreciated that early support.

    best wishes
    bill

  51. Thanks Bill.

    Perhaps I have inadvertantly exaggerated the issue somewhat. I have been a daily reader of Billyblog since my first post here and consequently have a better understanding of what makes everything tick.

    I will be sure to comment more regularly.

    cheers

  52. Hbl, in this world real accounting rules allow companies to value their liabilities at market-values. This is what many bank chose to do in this crisis when their bond values (and via CDS spreads) were depressed below the ground. This _accounting_ rule allowed companies to boost their reported p&l because they could value a bond at 70% which they were to repay at 100% at maturity (so a 30% gain, forget the details). A very decent capital gain. But all accounting rules require inter-temporal consistency and as market values started to recover p&l statements started to suffer from exactly the same effect but in the opposite direction. But then not every bank chose to apply this treatment

  53. and btw the fact that you value liabilities at market values does not change the aggregate amount of your liabilities – a decrease in value of market-held liability will lead to exactly the same increase in the shareholder liability (equity) via profit realized in this process.

    But then you also have tax effects and should be very careful choosing accounting rules. But it is the same story everywhere in the accounting. For instance, inventory valuation: FIFO vs LIFO

  54. hbl, Scott,

    I certainly couldn’t improve on Scott’s explanation of the MTM/BV issue. But here are some rambling thoughts, put forward on the hope they won’t be rejected due to technical difficulties.

    The “valuation” of equity as a corporate balance sheet item in financial accounting is not the same thing as its valuation according to the market value of the stock. Financial accounting produces book value of equity. This valuation is internal to the corporation. Market value is external.

    The corporation has certain obligations to both its debt holders and shareholders. The cash flow its shareholders will receive is less certain than with bonds, but the essence of an obligation still exists. Shareholders will receive any dividends if declared, and any breakup or sale value in the event of liquidation or acquisition. It is in this sense that the market value of equity can be viewed as the external valuation of the issuer’s “liability”, mirroring the same value as an asset to the shareholder. MMT implicitly views equity claims as liabilities as well as assets. Like debt, the net financial asset position of equity financial claims at the macro level is zero. This is an important analytical input to the framework whereby macro net financial assets of non government result exclusively in net claims on government.

    I think one of Scott’s salient points is the visualization of the share buyback. That perspective puts the valuation of an equity claim considered as a liability of the corporation on an equal footing as the valuation of the same equity claim considered as an asset of the shareholder. Think of the corporation as always having such a market transaction as a potential opportunity.

    Again, the “valuation” of equity as a corporate balance sheet item in financial accounting is not done according to the market value of the stock. It is a book value calculation. That is the case irrespective of whether some of the inputs into the calculation are market values (e.g. market value of financial assets or liabilities). Such a potential mixture of inputs is perfectly admissible within a single entity, depending on the financial accounting rules for valuation across different asset liability categories. Universal banks are a case in point. They use a so called mixed model (accrual and marked to market) for financial accounting in different parts of the portfolio.

    (And yes, certain liabilities can be valued at market for financial accounting purposes. That has been an issue during the credit crisis, when banks sometimes “gained” on certain liabilities whose market value deteriorated. It’s a necessary evil for consistency in some categories, but that’s another story.)

    In summary, it is critical to emphasize that the residual value of balance sheet equity is a book value item. This means that balance sheet equity value is the result of financial accounting events (even if such accounting includes certain market valued items) – not the result of continuous comprehensive revaluation according to the external value of the company’s own stock.

    At the macro level of sectors issuing and/or holding stock, it is possible to use either equity book values or equity market values in a high level exposition of accounts. But as Scott said, you must be consistent. You can use either book or market, but not both interchangeably.

    (You can use both as explicit items, but if you do, in order to ensure consistency, you MUST include the difference between the two as a necessary accounting adjustment somewhere in that model in order to reconcile the interface between various accounts. E.g. if setting up a macro model that integrates a macro view of equity as a market value asset with that of equity as a book value item on the corporate side, then it must include a reconciling item on the liability side that captures the difference between market and book in order to ensure a seamless interface between the liability side of the corporation and the asset side of those who hold the stock.)

    I think the difficulty relating to the discussion here lies largely in the decomposition of the (standard MMT) private sector into a household subsector and a business subsector (where business includes both incorporated and unincorporated forms as the complement of the household subsector). Then, in order to put Humpty Dumpty back together again, you must ensure a seamless accounting interface between the liability side of business and the asset side of households. (That consistent accounting interface then holds also where the asset holder is another business or some entity in the foreign sector.)

    As noted, business equity must be viewed as a “liability” in models where one is constructing an interface between the business sector and the household sector (or between the business sector and the foreign sector or between the business sector and itself). It is viewed this way implicitly in the standard government versus non government sector breakdown of the MMT model, as well as in the government, private sector, foreign sector breakdown. In either case, the business sector is embedded within a larger entity where the business liability interface is not an explicit issue for high level MMT accounting.

    E.g. within the non government sector, suppose a foreign entity holds a US stock. Then the macro stock value nets out as a liability of the US issuer offset by an asset of the foreign holder.

    Similarly, within the private sector, suppose a household holds a US stock. Then the macro stock value nets out as a liability of the issuer offset by an asset of the holder.

    In both cases, the net financial asset position due to the stock is zero at the macro and sector (non government in the first, private in the second) levels.

    Scott’s visualization of the share buyback is one way to rationalize a consistent interface between business balance sheet equity and other sectors using market values for equity asset claims. The buyback is a potential transaction in which the corporation actually affects its own financial accounting by transacting at the market value of its own equity. Note that when such a share buyback transaction is actually undertaken, the book value of any remaining equity will be adjusted down by the market value of the transaction. There is an actual calculation involving old book and new market values in order to get the new book value. It’s rather messy when you get down to the level of the new per share book value calculation – the per share book value goes down when the stock market value of the stock is greater than its prior book value.

    Another way of looking at it is that the market value of the stock is what the corporation might realize if it “sold itself” to a buyer for that same price. In that sense, it would realize its obligation or “liability” to its shareholders to realize the best price it could on such a sale, where the shareholder might receive that value in cash or stock from the acquirer. If the price is better than current market value, fine. That’s a new market value. But current market value is probably the most objective way of pricing in such an interpretation.

    There nothing in MMT sector financial balance accounting that is inconsistent with a complementary, more detailed view of economy wide balance sheets. The purpose of the MMT portrayal is to provide a stock/flow consistent approach to sector financial balances and flows, where the sector breakdown is designed primarily to highlight the marginal effect of government deficits and debt in terms of reconciliation with other sector flows and stocks.

    MMT decomposes the macro view into government and non government sectors. Non government decomposes into private sector and foreign sector. This framework is fully compatible with a more detailed view of balance sheets. The Fed flow of funds report is representative of such a view.

    The ultimate Fed flow of funds focus is on the household sector as the end claimant on the economy’s wealth. The sequential chain of real assets and financial claims stops at the household. This is evident in the fact that the household sector does not issue equity financial claims on its own balance sheet equity (net worth). Conversely, the household subsector holds all sorts of financial claims as assets, including direct debt and equity claims, similar claims indirectly through insurance and pension and mutual funds, claims on government, as well as holding its own real assets. Most of these various assets are marked to market. All of the economy’s real and financial wealth funnels into the household sector in this way (with the possible exception of some government owned property, but that is another story).

    The full decomposition of “net financial assets” in both the MMT and flow of funds sector breakdowns is complex. Keeping in mind the concept of business equity as a liability, we know that the highest macro level accounting for net financial assets amounts to a non government net financial asset position with government. Below that level, however, net financial asset positions of one sector with another can be found in a variety of forms, and across a variety of sectors. Of course, in MMT, the combination of foreign and private sectors (non government) has a net financial asset position with government. But also, in MMT, the foreign sector (relative to the current US position) has a net financial asset position with the domestic sector (government plus private sector). This is the result of cumulative current account deficits. In the flow of funds report, the household sector has a net financial asset position with the other sectors combined. (This includes netting of liabilities such as mortgages). In all of these combinations, the portfolio of net financial assets can include financial claims on any other sector, not just the government sector. In no way however does this contradict the high level measure of net financial asset claims of non government exclusively on government as per MMT. It is a matter of ultimate netting. And so there is no question that the MMT sector breakdown is entirely compatible with the Fed flow of funds breakdown. In the flow of funds report, micro “pieces” of macro MMT “net financial assets” (i.e. claims on government) can be found sprinkled as reserves, currency, and government debt throughout the asset positions of households (directly and indirectly through claims on the business sector) and the foreign sector.

    P.S.

    You’ll never resolve this over a beer.

    More likely, you’ll get S-faced trying and failing, and then waking up the next morning thinking you’ve found a brand new way of looking at the problem.

    The head hurts in any event.

  55. Greetings,
    I’m fairly new to MMT, it feels a bit weird at first, but it soon makes sense.
    Couple of points.
    Bill, would you consider creating a number of video lectures (something like you did with Randy), where you’d describe the mechanics of MMT. Title could be something along the lines of “what every citizen of a sovereign nation needs to know about its currency and economy” where you’d basically educate the broad audience on these things. It’s amazing that most people are very illiterate on most basic econ issues (even people with PhD’s in other fields). For my part I’ve been reading your blog for few weeks now and so far I have not been disappointed, your posts are very educational, clear, relevant, not opinionated, and spin free. However, I still manage to score poorly on your weekly quiz, but I’m working on it.

    I’ve been reading blogs of krugman, quiggin, de long, gittins,keen, etc for few years now, but they rarely or never describe the mechanics of the machine as lucidly as you do. So in that regard you’re a truly great teacher.

    Last the question, not to let the opportunity pass. Who knows maybe Bill responds.
    Here it is: is the purpose of taxation simply to control the inflation (i.e you tax in order to reduce the aggregate demand in an economy which which may or may not be running at full capacity).If not what is the purpose of inflation. Also why do governments issue bonds? (is it to reduce the liquidity in the economy, i.e inflation concerns). Last question, does the quantity of money matter?
    Many thanks.

  56. Correction “If not what is the purpose of inflation.” was meant to read
    “If not what is the purpose of taxation?”

  57. Hey hrvoje welcome

    I’m not Bill but I want to give an answer, to sort of test MY knowledge. I’ll see what the more senior members of the comment section say and compare it to my answer. I’m learning too.

    The purpose of taxation is to give the currency value (induce people to seek and spend it) and to control inflation. Eventually (like in the US now) people simply accept the currency and dont think about the coercive aspect to it but that is how it started. The inflation control aspect remains and is capable of being a quite effective inflation deterrent

    The issuance of bonds question is a little harder to unpack for me. The issuance of bonds is a way to allow people to exchange some of their future spending capacity for some secure FAs, it can also be a way to induce people not to spend now by offering attractive interest rates and finally it is a central bank tool for hitting its target overnight rate by draining reserves. It is NOT a way to acquire money to spend on govt programs

    Does the quantity of money matter is an interesting question and I will answer that differently now than I would have 2-3 weeks ago. First one has to define what you mean by money. Does the amount of credit card debt ( a form of money) matter? Yes it must be low enough to be serviced out of incomes. Does the level of bank reserves matter? Not to the ability to extend credit. They matter to central banks in regards to meeting their overnight rate targets but increased reserves themselves do not spill into the economy and become inflationary. Does the amount of circulating currency matter? I would say yes because most people are spending currency so increased currency probably matters a lot. One thing I think I can safely say is that the “quantity of money” as it is defined in many economic textbooks which use the quantity theory of money is quite useless in most modern economies. Especially in economies that are at well less than full employment, like most are today.

    The thing that many economic schools of thought dont do (and MMT DOES do) is understand that money behaves differently in different forms and at different unemployment levels. This, I think, is a relic of thought form the gold standard days when money was gold and gold was money period! Nice and simple yet completely inapplicable to modern capitalist societies.

    How’d I do Bill, Scott, Tom, JKH and other senior guys (you know who you are)

  58. Sergei,

    Thanks for weighing in… I was actually aware of the way companies can sometimes value debt liabilities at market prices thus impacting income statement and balance sheet, and had mentioned it above (probably lost in the volume of comments) as one of my reasons for focusing on shares instead of bonds. But my understanding is that this revaluing on the current balance sheet and income statement is never done as a result of changes in market prices of the company’s shares.

    JKH,

    Thank you for your detailed comments!

    Here’s the heart of the issue as I see it… I understand how MMT models net financial assets held by the non-government sector as entirely composed of claims on the government sector. As a self-consistent model it is entirely logical and I am not struggling to understand the approach chosen by MMT. My issue is whether that model serves a useful purpose in understanding reality (not every model reflects reality, as we’ve seen in this crisis!) I am already sold on the fact that the model reflects reality with respect to vertical transactions (government non-government), but am less convinced that it reflects reality for horizontal transactions (within non-government) for the reasons I’ve given in this thread.

    When trying to model the economy, we can either:

    1. Come up with a desired outcome (e.g., saying the non-government sector can’t change its net financial equity) and then figure out ways to make reality seem to fit that model. This is what I think MMT does with respect to horizontal transactions. You made statements like “The purpose of the MMT portrayal is to provide a stock/flow consistent approach to sector financial balances and flows”, and “MMT implicitly views…” and “That perspective puts…” and “in order to put Humpty Dumpty back together again, you must ensure a seamless accounting interface between the liability side of business and the asset side of households.” This “must” imperative seems to be based on a need to make the model “coherent” according to the pre-desired outcome.

    2. Attempt to model the way things actually work even if the model is more “messy”. You say that “In no way however does this [the approach of the flow of funds report] contradict the high level measure of net financial asset claims of non government exclusively on government as per MMT.” Really? My impression was that the flow of funds report shows the non-government sector’s net financial equity as GREATER THAN the negative net financial equity of the government sector, due primarily (perhaps completely?) to the decision not to treat shares issued as a liability of corporations.

    But even if the non-government sector’s net financial equity is larger than the negative net financial equity of the government, why is that not still sound accounting? Yes, that means that across the entire economy, financial assets are bigger than financial liabilities, but why do they have to balance at a aggregate level? Once you add in tangible assets, there is no question that total assets in the economy are larger than total liabilities. Does that make the economy “incoherent”?

    I understand that there are ways to rationalize a particular approach to reach the desired outcome, for example you say: “Scott’s visualization of the share buyback is one way to rationalize a consistent interface between business balance sheet equity and other sectors using market values for equity asset claims.” I’m just not convinced that this is the best representation of what drives current economic activity (as opposed to future hypothetical transactions). It seems like trying to contort reality to fit a model.

    One of the reasons I think all this matters, is, for example, using the MMT modeling approach alone as I understand it, no one would ever be concerned about stock market bubbles and the potential negative effects of them bursting (and therefore would not be motivated to lean against them forming). In the real world, there is no question that a burst stock bubble reduces the practical wealth of the non-government sector and hence the sector’s subsequent economic spending/saving choices. But in the MMT model, if the stock market drops in half, the net financial equity of the non-government sector hasn’t changed, so according to MMT modelling, why worry?

  59. Hi hbl,

    You said:

    if the stock market drops in half, the net financial equity of the non-government sector hasn’t changed, so according to MMT modelling, why worry?

    You started with the G/L model in the discussion here, so I will put their dynamics in words: Of course, it matters. The decisions made by production firms and households are different in their models. Household will have negative capital gains and a reduction in consumption. Firms will find themselves with lesser sales than expected and hence higher inventories. They will produce less in the next period and unless the government steps in, there will be a fall in the aggregate demand only to be saved by automatic stabilizers.

  60. Hi HBL,

    ” I’m just not convinced that this is the best representation of what drives current economic activity (as opposed to future hypothetical transactions). It seems like trying to contort reality to fit a model.”

    Don’t confuse the accounting in a model with “what drives economic activity.” NOBODY said that the macro accounting necessarily drives behavior. What we said is it is how you “keep score” of the activity. VERY different. G/L introduce all sorts of behavioral equations into their models to explain how activity is being driven, at least in their view, and there’s often not much accounting whatsoever in those equations. For instance, sometimes households want to reduce net saving even though they already have large debt and large debt service requirements . . . as in the late 1990s and the 2000s until a few years ago; sometimes, like now, they want to exactly the opposite. No MMT’er would ever suggest that you can simply use only accounting to explain these different behaviors. What we ARE saying via accounting and stock-flow consistency is that once they choose to net save, the only way this can actually be accomplished in the aggregate is via a larger government deficit, and we’ve also said that such net saving can be accomplished the easy way via aggressive fiscal policy as Bill/Warren suggest or the hard way via current modest automatic stabilizers in the tax code and unemployment benefits that just keep the macroeconomy from falling too far into a hole.

    Let’s take another example from our MV vs. BV example. Suppose the stock market gets bid up significantly over the next few months and households see the market value of their financial wealth grow. Maybe they start spending as a result. That’s fine, but an MMT’er would point out from the accounting relationships that this will reduce net saving of the non-govt sector even as households aren’t yet close to fixing their balance sheets as a whole. Indeed, substitute a rise in mkt value of real estate for the stock market improvement and you essentially have the MMT case for an eventual hard landing for the non-govt sector (in the absence of aggressive fiscal policy) we were describing to anyone who would listen for most of the 2000s.

    Best,
    Scott

  61. Ramanan & Scott — Thanks for clarifying that Godley & Lavoie supplement the core model with additional equations/dynamics related to behavior. That sounds like what’s been missing from the online MMT discussion (at least the parts I’ve followed). I need to actually read the book! But hopefully you understand how this incomplete picture provided by the core model alone could be confusing to a MMT newcomer…

    Scott —

    You didn’t answer my question about whether it would be sound accounting to have the total financial assets in the economy exceed the total financial liabilities.

    However when you mentioned “stock-flow consistency” again, I think something clicked for me. If you assume that stocks can ONLY be affected by flows, then I see how you might arrive at the type of model you have been describing, since the market repricing an asset is not the same as a flow. Perhaps that was part of the disconnect. So I suppose a model that allows the market to reprice assets but not liabilities would be “stock-flow inconsistent”. Now I don’t think that makes such a model WRONG, it just wouldn’t follow the particular convention of stock-flow consistency.

    I see the logic, but I’m a little wary of using it without lots of disclaimers, as I don’t think it’s the way the markets actually work. People assign values to markets (and works of art) as a subjective decision, and the assigned values are not constrained by the flow of anything. In this way money/asset flows are NOT like streams flowing between lakes (or other analogies of physical systems). Hopefully you are away of the “money on the sidelines” fallacy, for example.

  62. hbl,

    My own view of the “intellectual superstructure” of MMT is that it consists of two distinct components:

    a) Analysis of monetary system accounting and operations
    b) Policy formulation

    With respect, I believe you’ve made a fundamental error in each of these components.

    With respect to the first (analytical) component, you noted, “My impression was that the flow of funds report shows the non-government sector’s net financial equity as GREATER THAN the negative net financial equity of the government sector, due primarily (perhaps completely?)”.

    This is incorrect. The Fed flow of funds report among many other things shows the household sector’s net financial assets as greater than the size of MMT net financial assets with the government. This is very different. Apparently you did not absorb what I said in my first comment:

    “The ultimate Fed flow of funds focus is on the household sector as the end claimant on the economy’s wealth. The sequential chain of real assets and financial claims stops at the household. This is evident in the fact that the household sector does not issue equity financial claims on its own balance sheet equity (net worth). Conversely, the household subsector holds all sorts of financial claims as assets, including direct debt and equity claims, similar claims indirectly through insurance and pension and mutual funds, claims on government, as well as holding its own real assets. Most of these various assets are marked to market. All of the economy’s real and financial wealth funnels into the household sector in this way (with the possible exception of some government owned property, but that is another story).

    The full decomposition of “net financial assets” in both the MMT and flow of funds sector breakdowns is complex. Keeping in mind the concept of business equity as a liability, we know that the highest macro level accounting for net financial assets amounts to a non government net financial asset position with government. Below that level, however, net financial asset positions of one sector with another can be found in a variety of forms, and across a variety of sectors. Of course, in MMT, the combination of foreign and private sectors (non government) has a net financial asset position with government. But also, in MMT, the foreign sector (relative to the current US position) has a net financial asset position with the domestic sector (government plus private sector). This is the result of cumulative current account deficits. In the flow of funds report, the household sector has a net financial asset position with the other sectors combined. (This includes netting of liabilities such as mortgages). In all of these combinations, the portfolio of net financial assets can include financial claims on any other sector, not just the government sector. In no way however does this contradict the high level measure of net financial asset claims of non government exclusively on government as per MMT. It is a matter of ultimate netting. And so there is no question that the MMT sector breakdown is entirely compatible with the Fed flow of funds breakdown. In the flow of funds report, micro “pieces” of macro MMT “net financial assets” (i.e. claims on government) can be found sprinkled as reserves, currency, and government debt throughout the asset positions of households (directly and indirectly through claims on the business sector) and the foreign sector.”

    The MMT sector analysis and the FFF sector analysis are completely compatible. From a mathematical perspective, they are two different representations of the same multi-dimensional economic space, using a different selection of primary dimensions, and partitioning the full space into different subspace breakdowns according to that dimensional delineation. However, they are both complete representations of the same economic space.

    Moreover, it is a simple matter of migrating at will between the two spaces and the interpretations associated with each, depending on the analytical task at hand. The private sector subset of the MMT space commutes directly with the combination of the business and household sectors in the FFF space. Much of my commentary above was devoted to this.

    With respect to your error noted above, it is a simple matter of aggregating the FFF subspaces of businesses and households in order to form the MMT subspace of the private sector. From there, one simple uses the same valuation methodology for all business sector liabilities, including equities, as I described above. The result is an indisputable equivalence of the areas in question.

    As I said, the MMT and FFF analytical spaces are completely compatible. If desired, you can view MMT as a gateway into FFF (enter via the private sector). Or you can view it vice versa (enter via the combination of the business sector and the household sector).

    Consider the view of MMT as a gateway into FFF (among other things). Think of MMT as the superhighway of sector financial balance analysis. Then think of FFF as an off ramp into the underlying balance sheet details of the private sector and the foreign sector (and the government sector if you want).

    The fact that I can choose to take an off ramp to the suburbs gives me some flexibility in the depth of analysis, depending on immediate purpose. The fact that it is a choice certainly doesn’t mean I’ll never make it my choice.

    Your view seems to be that MMT is somehow a constraint on the view that one has of the real world. It is no such constraint. It is a way of organizing one’s set of windows into the real world.

    With respect to the second (policy) component, you noted “But in the MMT model, if the stock market drops in half, the net financial equity of the non-government sector hasn’t changed, so according to MMT modelling, why worry?”

    Quite separate from the analytical error already noted, MMT says no such thing about policy related to the stock market. (I include “worry” as an aspect of policy.)

    With respect to the example of the stock market falling in dramatic fashion, MMT policy formulation would consider such an event at least as seriously and rationally as any alternative mode of policy formulation. It would consider it largely in the context of its effect on aggregate demand. Indeed, this site along with Mosler and Kansas City are replete with policy proposals for how the financial crisis, including the stock market meltdown, should have been considered from a policy perspective.

  63. It seems to me that MMT (a financial accounting model) needs to answer reaction issues of reality. Is behavior a response to danger perceptions and scarcity reflections( technical conditions)? Is there an impact phenomenon and recovery reaction from occurences? Is there an information presentation from messages released from the impact and their impressions formed that influence reaction to occurences? Food for thought! I am a mathematical economist and part time philosopher that understands basic accounting but I also seek surprises in occurence whose discovery is the basis of wisdom. Consistent stock-flow accounting is a good but static photo of reality and as a series has an approximation of occurence but there is more to it! Where is the surprise? Is the photo enough to know all about the occurence displayed by the picture? MMT prescriptions for policy are practical and make more sense than neoclassical synthesis but does the hypothesis explain the “black box”?

  64. JKH-

    I only have a few minutes (until much later today) so I will have to re-read your response and absorb it better later. Two quick points though:

    1. If MMT is a way of organizing one’s set of windows into the real world, we’d want to make sure the windows are facing the right direction, are not smudged, etc… And compare with other ways of organizing the windows. I’m just trying to understand the limitations of the MMT-specific configuration.

    2. I believe I did understand your detailed point about how “all of the economy’s real and financial wealth funnels into the household sector in this way” etc. My two reasons for asserting that non-government net financial equity in the Z1 exceeds net government financial liabilities are:

    a. Page 62, Table L.5 lists “Corporate equities” under “Financial assets not included in liabilities:”. Am I misinterpreting this?

    b. On page 30 of the Godley/Lavoie book it says “Another way out, which national accountants seem to support, is to exclude the market value of issued shares from the liabilities of the firms. This is the approach taken by the staticians at the Federal Reserve.”

    Again, thanks for your patience… I will have to re-read your last note later to ponder what I may be missing.

  65. hbl,

    Good point on direction and smudging. I know from personal experience that tackling an off ramp in reverse doesn’t work well when the rear window is blackened.

    🙂

    Regarding L.5:

    The entire L series is about credit market debt, which excludes equities. That’s not a comprehensive balance sheet for the economy.

    To get to the latter, you must go to B.100 on page 104.

    What you will see there among many other things are corporate equities held directly by households of about $ 7 trillion. The rest of the corporate equities are held indirectly by households as a result of their financial claims on institutions that hold those equities – mutual funds, life insurance, and pension funds (indirect as per my description above). Also included are equities held in non-incorporated business which is an important category as well.

    I understand that the Godley/Lavoie book is great, but I don’t have it. I’d have to see the context for your quote. But I believe Scott already suggested that my approach is generally consistent with theirs.

  66. General observation:

    Again, MMT (in my personal outside view) consists of two components:

    a) Analysis of monetary system accounting and operations
    b) Policy formulation

    The effective execution of the first component is a necessary but not sufficient condition for the second. It is on this basis that all forms of neoclassical economics are excluded from the possibility space for effective execution of the policy component – unless they happen to get something or other right purely by accident (rare, apparently).

    It seems that much of the criticism coming from new entrants to the MMT observation deck are in the form of alleged shortcomings of the analytical framework to answer questions about policy. That’s not what the analytical framework is supposed to do. It is intended to describe existing monetary operations and accounting. That’s all. It is critical groundwork because neoclassical economics remains handicapped by an incorrect understanding of these operational and accounting issues. The neoclassical belief in the money multiplier alone should have been enough of an iceberg to sink that Titanic a long time ago. But such is the challenge in merely getting to a sensible analytical foundation for policy making.

  67. JKH,

    I have a few minutes but not long enough yet to fully absorb your previous comment, however:

    1. With respect to (a) analysis of monetary system operations and accounting and (b) policy formulation, your point is a good one, and I realize they are independent. And I’ve stated repeatedly that I think the policy implications of the MMT understanding of the economy are highly relevant (especially with regard to the vertical). My questions are around how to choose to model the monetary system in a way that BEST informs the related policy formation and is truest to the underlying economic reality. And it’s helpful to see references to the types of additional analysis that MMT-practitioners use to reach policy recommendations.

    And as I’ve said I think the focus on “non-government can’t change its own net financial assets” may serve as a useful backdrop to emphasize the role of vertical operations, but I still find it slightly misleading when looked at alone with respect to understanding the horizontal, and am not fully clear why it’s necessary other than to balance textbook matrixes.

    2. I was aware of the Z.1 balance sheet tables, thanks. B.102 (nonfinancial corporate balance sheets) lists for Q3 2009:

    a. Tangible Assets: $12556bn
    b. Financial Assets: $14111bn
    c. Liabilities: $13448bn
    d. Net worth: $13218.7 [d = a + b – c]

    and in a “memo” section:

    Market value of equities outstanding: $12081bn

    (Just out of interest, looking at the historical data, the ratio of market value of equities to the corresponding aggregate corporate balance sheet net worth ranges from 0.33 to 1.75 since 1945.)

    B.102 further breaks down the “financial liabilities” but the issued shares do not seem to be among them (the bulk is credit market instruments and bonds). That means corporate net financial assets are NOT reduced by the size of the market value of the shares, so when adding all sectors together, the non-government sector will have a total net financial equity exceeding the government sector’s net financial liability… since market share prices are adding to household net equity (directly or via other instruments held by households) but not subtracting from corporate net equity. Right?

    The Godley & Lavoie context suggested to me the same conclusion.

    It feels a bit silly to dwell on this now as I realize it’s not THAT important, and the Z.1 data is there to do the additional step of subtracting market value of shares, but it helps explain where I was coming from with my questions about the use of “real world” accounting.

  69. BTW, I sent an email to Representative Fattah. In it I said that I agreed that the National Debt is a burden on people, and that it would be a good idea to reduce it. I suggested that that be done, not by taxation, but by simply not issuing new debt. (Or maybe doing so selectively, such as to domestic pension funds.) The Federal Reserve would still have to pay the government’s bill, of course. That way we would take a great burden off of the American people without taking a lot of money out of the economy. 🙂 I suggested that he read Galbraith’s article, “In Defense of Deficits” ( http://www.thenation.com/doc/20100322/galbraith ).

    I doubt if he will withdraw the bill (fat chance, that!), but at least maybe he will read the Galbraith article. I sent a copy to my own Congressman, too. Stop the debt hysteria!

  70. bill says:
    Friday, March 5, 2010 at 18:06

    Dear Lefty …. I try to keep my blogs as simple (in analytical terms) as I can.

    Maybe Bill was born in the year of the Monkey – he does like to range over the journal treetops and throw twigs and branches at his favourite nemeses, the ‘deficit terrorists’. On the other hand somewhere somebody once said “nobody is your enemy and nobody is your friend”! Like lefty I listen to the pundits discuss and teach MMT, print out bits and pieces to think about, underline and highlight, and appreciate the learning process. MMT is an edifice of logical thought and you learn to admire the beauty and simplicity of its foundations. The mechanics of its application in a complex modern world, for me at least, is secondary to its fundamental significance. ‘Human beings need not live in dire economic bondage – but greed and stupidity must first be overcome’. It’s as fundamental as the desire for peace, extant on this earth for as long as we have been around. If somebody is willing to teach and somebody is willing to learn and listen, then that’s stock – flow consistency to me.

    It doesn’t really astound me, perplex or worry me that people don’t ‘get’ MMT. That doesn’t mean that I am not sensitive to all of the pain and suffering in the world. Human beings can actually ‘feel’ far more readily and deeply (though they may be too busy to notice) than they can think – academics in particular forget this. All children learn through feeling, before they are put into a school and taught to view the world only through the prism of (often erroneous, fragmented and definitely bounded) conceptual structures.

    Among us we have people whose intelligence is all but asleep; people bewildered by their environment or events; people in whom the desire nature is rampant; people who are swayed by the mass consciousness; people who are beginning to think; people who are beginning to understand and appreciate the depths of the human love nature; people who are mystics or occultists; people who want to serve; people who see something beyond the hustle and bustle of the existence we have created for ourselves on our earth – each is absolutely unique!

    If you redefine human intelligence as developing consciousness, in particular self consciousness – fully integrated with other human beings and in full control of all aspects of the personality life (physical, emotional, mental and the ‘I’), then it becomes clear why MMT is not easily perceived. Basically, human intelligence is not all that intelligent. Over the panorama of the ‘landscape as it is’ are drawn the myriad veils of ego, wrong intellection, emotional miasma, physical entrapment. Politicians are generally highly educated, but you cannot equate intellection with intelligence if you read today’s news! Our scientists overall, because of their intellectual rigor and genuine concern, offer far more in 2010 to humanity than do the financial or governance processes.

    All aspects of our lives (political, psychological, knowledge) arise from the one human nature and it is only after their full development and harmonious integration emerges what I would posit as the promise of the evolutionary trend – a stable, kind and generous, thoughtful and considerate, logical and sensitive human personality – grounded in their own humanity; helping where they can, being helped where they can. I don’t know how they would tack that image on to the end of the journey from the planet of the apes, or hazard a guess as to what lies beyond?

    If we need somebody or something to work on, whilst we make our contributions and pay our dues, we probably need look no further than ourselves – minding your own business (personal or international) and giving everybody else enough elbow room and respect to be themselves is highly underrated I reckon. On a planet full of people (black white red yellow brown and every beautiful colour in between) who all hate being controlled, there is a lot of controlling going on. That’s the power of ego eclipsing the potential of the human being. Life should be all about developing human potential! [Self consciousness]

    Dear Lefty – all viewpoints I believe are relevant because Life is the real 360 deg. debate: you and I are the greatest problem we face in that debate. Solve it for ourselves, and at the least we have done our little bit.

    Warm regards,

    jrbarch

  71. JKH,

    Thanks, I look forward to hearing what I got wrong, if and when you get a chance.

    Until then let me respond now that I’ve more carefully re-read your comments at 3:13 about my alleged two fundamental errors:

    1. Regarding monetary system accounting… I do understand that the household sector’s net financial assets are greater than the size of MMT net financial assets with the government, but that’s not what I was looking at. Basically I was looking for evidence that the national accounting puts the market value of shares/equities on the liability side of SOME balance sheet, given that the market value of shares/equities are used on the asset side. Without the market value used on both sides (or book value on both sides), that implies that the Z1 accounting doesn’t follow the MMT convention of net financial assets of the non-government sector being exactly equal to the net financial liabilities of the government sector.

    2. Regarding policy… When I said “But in the MMT model, if the stock market drops in half, the net financial equity of the non-government sector hasn’t changed, so according to MMT modelling, why worry?”, you said “MMT says no such thing about policy related to the stock market.”

    But I didn’t claim MMT practitioners would say no such thing, I very specifically said “according to MMT modelling“. Of course I recognize that policy is not driven exclusively by models.

    One of the reasons this actually seems relevant to me is expressed my comment early in this thread… Multiple MMT authors consistently seem to put brief government surpluses in the late 1990s as the cause of both the subsequent recession and the acceleration in private sector debt. In the 5-10 times I’ve seen this claim I’ve never seen it accompanied by any mention of the stock market bubble bursting, so it probably magnified my concern that treating changes in stock prices as having no effect on net financial equity within a model could cause an MMT practitioner to not recognize the related behavioral effects. Of course one answer to this could be that I’m wrong to question the government surplus as the primary driver of the recession and debt buildup, but I’m waiting to see more evidence on that.

  72. Hbl, I have big problems trying to understand why you are so much concerned about equity values and where they are reflected. To me it seems like your question is whether human civilisation is able to create value or not. Yes, it can and it does. And we have it around us. If you question where everything that surrounds us comes from then the answer is energy that we consume. That is the liability side of the balance sheet in physics but it has nothing to do with financial assets.

    MMT is about fiat money system that this world lives in and fiat money is the anchor of MMT foundations. Equities are not fiat, they are claims on real things. Same applies to corporate bonds any other private financial assets. They are claims on real assets somewhere else in the economy. And they are not fiat. They have real value. But this value is subjective. One person attaches one value, another person another value and without this difference there would be no transaction and only transaction can put some number on this value. However it is very difficult to accept the argument that if the crowd which thinks of higher value is larger than the opposite crowd then it should have big relevance to monetary system. No it does not. It simply tells you that this world is never in equilibrium and therefore asset values are never stable. But at the end of the day the price expressed in fiat money of private claims on real assets has nothing to do with monetary system but rather describes the direction of disequilibrium in the economic system. And then it becomes the topic of policy making which gives a “real asset” some anchor with regards to what is really valuable (not in fiat sense) today for today’s generation of people which will ultimately decide on particular policy. Do we need a housing boom? Yes or no? Do we want to experience internet bust? Yes or no? Do we agree with 10% unemployment because it allows capital to extract higher rents? Yes or no? Do we want to have universal health-care? Yes or no? Finally do we need exchange traded claims on real assets in economy in order to confuse economic thinking? Yes or no? If the answer is “no” then the respective asset will by definition lose its real and monetary value.

    MMT never discusses what to do with real assets and how to react to their values expressed in fiat money and leaves this topic solely to policy design which is the result of political consensus. Human civilisation can destroy value much faster than it can create it but this outcome is also the result of political consensus.

  73. Hi hbl,

    Trying to read your mind . . . you are saying that G/L use the market value of liabilities, company accountants use book value and the Fed – they don’t even inlude that in the liabilities.

    Imagined Question: Which one is correct ?

    Answer: All three.

    Imagined Question: Does that mean if one were to follow the Z.1 accounts, one can claim that the private sector can itself run on its own without the government coming in between?

    Answer: It will be highly unstable. I do not have a proof at the moment, but this is an attempt – the households’ propensity to save keeps changing all the time. If the household sector decides to save more and hence consume less, the production sector will find itself with a higher stock of inventories and this will lead to less investment both in inventories and fixed capital. The production sector will also report less profits and hence less dividends and this will lead to a fall of stock market prices. (The equity market behaves in a crazy way, but this possibility will happen soon) The production sector will also borrow less from banks and their profits will hurt too. Back to households – they will find themselves with lesser wealth, having suffered capital losses and will consume less. This will send the whole economy into a free fall! There will be mass unemployment and no way to come out of the situation. Alan Greenspan and Ayn Rand do not know or understand this!

  74. hbl,

    You will find many posts by Bill on why surpluses are bad.

    A rule of thumb as far as government taxing is concerned is that the governments are price setters and quantity takers. They set the tax rates and the private sector decides on how much quantity of taxes are to be paid. (Of course, higher tax rates will put upward pressure on the quantity of taxes paid). Unfortunately this does not lead to pleasant situations. The surpluses you were talking of were led by huge capital gains because of stock market movement. A surplus leaves the private sector with lesser income – they will consume less because of having found themselves with lesser incomes and the recession will arrive sooner or later.

    The Clinton government could have acted on this and increased government spending – instead they congratulated themselves and put the United States into an unsustainable path of growing by increased private sector borrowing.

  75. Hi Sergei,

    “I have big problems trying to understand why you are so much concerned about equity values and where they are reflected.”

    The length of this thread has grown disproportionately long relative to my level of concern! I tried to wrap up half way but then new commenters kept me going 😉

    “To me it seems like your question is whether human civilisation is able to create value or not.”

    That wasn’t my question… And I do agree with most of the rest of your comment.

    My questions boil down to:

    1. Why does MMT use unnecessarily unrealistic modeling of the horizontal (non-government) especially but not exclusively as it relates to share dynamics in order to make textbook matrices balance?

    2. Can this mislead MMT-inspired thinking when analyzing historical events and setting policy for the future?

    3. Is blaming the early 2000s recession on the government surplus with never even a mention of the stock market bubble an example of this?

  76. Hi Ramanan,

    “you are saying that G/L use the market value of liabilities, company accountants use book value and the Fed – they don’t even include that in the liabilities.”

    Yes. And thank you for your answer.

    As for whether the private sector can run itself, that’s not where I was going with this at all. I’ve said I agree with the vertical role of government in all this. I see the private sector as susceptible to the “stability breeds instability” dynamics described by Minsky and to which you indirectly refer in your example.

    “You will find many posts by Bill on why surpluses are bad.”

    I understand that government surpluses can cause recessions and worse. The question is whether EVERY recession is caused by a government surplus.

    “The Clinton government could have acted on this and increased government spending – instead they congratulated themselves and put the United States into an unsustainable path of growing by increased private sector borrowing.”

    I agree that the government could have intentionally swung to deficit sooner to reduce (and perhaps prevent) the recession, but to me that is very different from saying the government surplus CAUSED the recession period without (in the posts I’ve read) a mention of the other dynamics that were in play at the time. (Stock market bubble, some borrowing to consume beyond basic needs due to rampant “consumerism”, and the role of technology and globalization in holding down low skilled wages).

  77. hbl,

    A budget surplus is neither a necessary nor a sufficient condition for a recession. One has to look at the external sector as well. Of course, there are so many other factors. On the other hand, a current account deficit and a budget surplus is very likely to throw a country into recession. More importantly, national accounting in a stock-flow consistent approach is the most powerful way to study such things.

  78. Hi hbl,

    I agree that the government could have intentionally swung to deficit sooner to reduce (and perhaps prevent) the recession, but to me that is very different from saying the government surplus CAUSED the recession period . . .

    Yes I completely agree with you. However, it is the government’s job to take control of the situation. The government has statistics updating on a daily basis – they should increase spending anytime the graph seems likely to move to a surplus. More generally active fiscal policy is needed with policy makers/advisors having an excellent graduate school training in how modern money works.

    The mood was so “good” in the late 90s that they (the CBO) announced that they will retire the public debt in 15 years or so – without understanding that that will send 300 million American people into bankruptcy!

  80. Dumb question:

    What is the MMT definition of “net savings” at macro and micro levels?

    I have always assumed that, in a closed economy, “private net savings” = S-I = “government net dissavings” = G-T at the macro level; so “net savings” of a sector/entity more generally would be equal to the change/increase in NFA of that sector/entity (?), and hence that a sector cannot net save or dissave by itself.

    I was confused by Scott’s comment “Suppose the stock market gets bid up significantly over the next few months and households see the market value of their financial wealth grow. Maybe they start spending as a result. That’s fine, but an MMT’er would point out from the accounting relationships that this will reduce net saving of the non-govt sector even as households aren’t yet close to fixing their balance sheets as a whole.”

    Which SEEMED to imply (no doubt my misinterpretation) that household spending within the non-govt sector could reduce net saving of the entire non-govt sector, as opposed to merely the household sector.

  81. Hi Paradigm Shift

    I’ve been a bit sloppy of late in my use of terms like “leverage” and “net saving,” so apologies there. I was presuming that the increased economic activity due to the stock market bubble would improve the government’s budget position via automatic stabilizers (more income means more taxes paid, more capital gains taxes, many moving into higher tax brackets, less unemployment benefits paid, etc.), and so the net saving of the non-govt sector would fall. That’s mostly what happened in the late 1990s to generate budget surpluses; there were some proactive efforts to reduce govt deficits by Bush I and then Clinton, but these alone would not have generated govt surpluses by 1998 even if they had not had negative effects on GDP (which they would have, in my view, and so I don’t think they would have even created the balanced budget they were anticipating by 2002). It is true, though, that if you assume a govt with absolutely no automatic stabilizers that net saving would not have changed for the non-govt sector even with the stock market bubble, ceteris paribus. Also, even in that case, you could possibly (if you make the right assumptions) have the household sector reducing net saving as the firm sector increases it.

    Best,
    Scott

  82. Ah.. thanks, Scott. That makes much more sense to me now. Appreciate you taking the time to expand.

  83. Scott,

    Thanks for the link — it’s meaty enough that I’ll have to read it later and follow up, but I see that you do discuss the 1990s bubble in stocks and mentality. Regarding my claim, apologies if it turns out to be a misunderstanding or misrepresentation on my part, but here are some examples of how I formed that opinion (just based on a quick search, I remember reading others):

    Bill Mitchell: “Bush’s deficits followed the sabotage of the Clinton surpluses, which drove the US economy into recession in 2001.”

    Bill Mitchell: “Yes, President Bush inherited the destructive Clinton surpluses which not only squeezed the private sector of liquidity and set in place the rising private indebtedness but ultimately pushed the US economy into recession in 2001 on the back of the fiscal drag.”

    Bill Mitchell: “But we also have to step back and understand that the 2001 US recession was a direct product of the Clinton surpluses which dragged the economy down and promoted the incentives for workers to increase their borrowing to maintain their consumption levels.”

    Randall Wray: “The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929. (Do you see any pattern? Take a look at the dates listed above.) With the exception of the Clinton surpluses, every significant reduction of the outstanding debt has been followed by a depression, and every depression has been preceded by significant debt reduction. The Clinton surplus was followed by the Bush recession, a speculative euphoria, and then the collapse in which we now find ourselves. The jury is still out on whether we might manage to work this up to yet another great depression. While we cannot rule out coincidences, seven surpluses followed by six and a half depressions (with some possibility for making it the perfect seven) should raise some eyebrows. And, by the way, our less serious downturns have almost always been preceded by reductions of federal budget deficits. I don’t know of any case of a national depression caused by a household budget surplus.”

    I raised some questions on this topic here and here, including linking to charts/data that I thought contributed to an alternative view.

    Coincident with the government surplus (primarily 1999-2000):
    Rising inflation, high capacity utilization, record labor force participation, falling unemployment, real GDP growing quickly (4-5%), rising real disposable personal income, rising total wealth (chart of levels, chart of annual rate of change), rising government spending, etc.

    It’s not clear to me why the responsible thing under these conditions would have been for government to avoid surplus (which I see as a symptom not a cause in this case) by spending even more or taxing less. Of course I understand that once the bubble peaked and the non-government sector tried to increase its savings rate that only the government can facilitate that (by running a large enough deficit).

  84. Hi Ramanan,

    “A budget surplus is neither a necessary nor a sufficient condition for a recession…”

    Agreed.

    “it is the government’s job to take control of the situation… they should increase spending anytime the graph seems likely to move to a surplus.”

    I understand that the government should facilitate the non-government sector’s desire to increase its savings rate. I’m less clear on why the government should actively fight (via the level of government deficit) the non-government sector’s desire to decrease its savings rate, at times when that occurs. (Such as during “new economy” bubble eras).

  85. Hi HBL

    Maybe Bill disagrees with me, but “Clinton surpluses” as I’ve seen Randy/Bill/Warren use it through the years generally refers to the fact that there were surpluses during Clinton’s presidency, not much more than that. I think most every MMT’er would agree that far and away the main cause of the surpluses during 1998-2001 was the stock market bubble; there were some proactive acts by Clinton and Bush I to reduce deficits, but these efforts pale in comparison and would likely never never have actually created surpluses on their own (given the AD suppressing nature of attempts at creating surpluses, that is).

    Also, for me at least, given the sector financial balances approach that is at the core of MMT, saying “surpluses caused the recession” is virtually the equivalent of saying “the reduced net saving position of the non-govt sector ultimately resulted in recession.” In other words, you can’t get sizeable private sector net dissaving (which is the point of arguing govt surpluses are going to induce instability—we’ve noted many times they aren’t necessarily instability inducing if accompanied by large trade surpluses that enable the domestic private sector to continue to net save) without some usually rather strong incentive to leverage on the part of the non-govt sector like a stock market or real estate bubble, and the flip side of this is a govt surplus.

    Therefore, while I have always considered the recession due to the collapse of the stock market bubble, putting my points together here (stock bubble is the main cause of the surpluses, surpluses are the flip side of pvt sector net dissaving) I don’t find that inconsistent with the statement “surpluses caused the recession.” In fact, I consider them to be equivalent.

    Again, that’s basically what I demonstrated in the link I provided you in Figure 9 and the discussion of the figure. Thus, I personally don’t find anything inconsistent with your quotes from Bill and my previous point that there isn’t much evidence MMT’ers “never even mention” the stock market bubble (quoting you there) as the cause of the early 2000s recession.

    At the very least, my post from July DOES demonstrate that AT LEAST ONCE an MMT’er HAS stated explicitly that the stock bubble was at the core of the instability that led to recession (so you certainly can’t say “never”), but again I think all the others have recognized the stock market bubble as quite fundamental to the 2000s recession. In fact, I recall a number of pieces Randy did, some of them for Levy, in the late 1990s predicting a recession was on the way using all the basic MMT accounting tools you are critiquing in this thread. The Strategic Analysis posts there were also making much the same arguments.

    Best,
    Scott

  86. Hi HBL . . . one more:

    “I’m less clear on why the government should actively fight (via the level of government deficit) the non-government sector’s desire to decrease its savings rate, at times when that occurs. (Such as during “new economy” bubble eras).

    Go and read stuff published during that period . . . we generally weren’t arguing for larger deficits per se given a stock market bubble, but trying to alert others regarding the instability building and explaining why one shouldn’t believe the national debt would be or should be retired (CBO was predicting this would happen by 2010 or something like that). My recollection of MMT publications then is of a lot of stuff about how (a) the Clinton rising tide was lifting all boats (hence the need even then for a job guarantee), and (b) large deficits would be necessary to stabilize the macroeconomy once net saving desires turned around in the private sector. Much like now, we (actually they, as I was just a grad student at the time) were advocating a different approach to policy overall–monetary (low, fixed nominal rates; cb’s can’t actually target inflation), fiscal (job guarantee), financial regulation (much like now–focus on reducing the macro destabilizing effects of financial markets).

    Perhaps my memory fails me, but I was absorbing everything these guys were writing then, and I was in contact with Randy, as he was on my dissertation committee.

    Best,
    Scott

  87. One more yet, HBL . .

    “Regarding my claim, apologies if it turns out to be a misunderstanding or misrepresentation on my part, but here are some examples of how I formed that opinion (just based on a quick search, I remember reading others):”

    No worries at all. I don’t think you’re the first to make this argument actually, and though I do think it’s a misrepresentation, I can see how such an interpretation would be formed. Also, Bill/Randy/Warren may or may not agree with all I’ve said above–we don’t always have to agree with each other on everything 🙂 Regardless, what I’ve said above has been my interpretation of all this going back to the late 1990s, actually, for what it’s worth.

    Best,
    Scott

  88. hbl,

    I’m always amazed by responses to explanations of errors made where people say they quite understood the explanation of the error, but that really wasn’t the point they were making. Such was the case around the Z1 L series interpretation, as per your comment @ Saturday, March 6, 2010 at 3:39. But beyond that, let me modify the tone of my last response from “you’re wrong” to “you’re wrong, and here’s how I would reconstruct the approach in the context of trying to be correct.” It seems you’ve not quite absorbed Scott’s sequence of explanations about accounting logic as well, so I have no illusions about what I might accomplish here. Accordingly, this final effort on my part is for my own benefit as much as anything.

    With that, regarding your comment @ Saturday, March 6, 2010 at 6:03:

    “B.102 further breaks down the “financial liabilities” but the issued shares do not seem to be among them (the bulk is credit market instruments and bonds). That means corporate net financial assets are NOT reduced by the size of the market value of the shares, so when adding all sectors together, the non-government sector will have a total net financial equity exceeding the government sector’s net financial liability… since market share prices are adding to household net equity (directly or via other instruments held by households) but not subtracting from corporate net equity. Right?”

    I said this was wrong in my preliminary response. There is a short form explanation and a long form. I’ve already given the short form explanation in a number of comments, but I’ll repeat it again in other words here. And then I’ll get to the long form in the rest of this comment.

    The financial asset that corresponds to balance sheet equity is an ownership claim on balance sheet equity – i.e. an equity claim such as common stock. The ownership claim is distinct from the balance sheet equity entry itself. The financial asset is the stock – not the balance sheet equity. So with respect to an MMT consolidation of business and household balance sheets, if you go looking for financial liabilities directly on the equity portion of corporate balance sheets, you won’t find them there. That’s consistent with the financial accounting principles according to which corporations split their balance sheet between assets, liabilities and equity. If you want to find the liability that corresponds to stock as an asset, you have to look at the stock itself, not the corporate balance sheet. So the liability in the sense of MMT consolidation is the same as the asset – the stock. I’ve explained the liability interpretation of a stock at length already. Both the asset and liability valuation for the stock generally implies using the market value of the stock as the basis for consistent valuation. But if for whatever reason one CHOOSES to write down both the asset and the liability to book, that can be done for purposes of illustration, but that’s purely a discretionary valuation choice, however as odds with congruent financial accounting it may be and for whatever reason it might be chosen. What can’t be done is for one to ascribe a market value for a stock held by a household, while extracting financial accounting equity book value entry on a corporate balance sheet, and then claiming there is a mismatch between a financial asset and a financial liability. Scott and I have explained repeatedly why this is inconsistent. And therefore it is equally illogical to suggest that a “net financial asset” has been created simply due to the difference between corporate book value and the value of a stock held by a household. That would amount to netting a balance sheet entry that isn’t a financial asset (balance sheet equity) from the value of a financial claim (stock) that is a financial asset. It’s simply illogical. And that’s the short version of my response.

    Now I have a longer version explanation, which at the same time responds to your comment @ Saturday, March 6, 2010 at 15:19:

    “Basically I was looking for evidence that the national accounting puts the market value of shares/equities on the liability side of SOME balance sheet, given that the market value of shares/ equities is used on the asset side. Without the market value used on both sides (and book value on both sides), that implies that the Z1 accounting doesn’t follow the MMT convention of net financial assets of the non-government sector being exactly equal to the net financial liabilities of the government sector.”

    Z1 follows financial accounting principles for business balance sheets. That means in the case of corporations that balance sheet equity is a book value calculation in the sense that its valuation is quite separate from changes in the market value of common stock. It reflects ongoing operations of the firm – not the stock market’s assessment of them. In the case of unincorporated business, the same financial accounting principles hold, although there is no publically traded market for the stock against which to compare the book value of balance sheet equity.

    Z1 follows market value accounting (for the most part) in order to value household balance sheets.

    You say that Z1 doesn’t consolidate accounts in accordance with the MMT NFA accounting convention.

    That is wrong.

    The reason that it is wrong is that Z1 doesn’t consolidate corporate and household balance sheets AT ALL. The reason it doesn’t is that it doesn’t NEED to. To do so would be completely redundant. The reason it would be redundant is that the Z1 household balance sheet presentation depicts a domestic valuation of the entire economy through the lens of the end claimant on its wealth – which is the household. (This sets aside the smaller net foreign investment piece.) Again, I noted earlier the nature of this Z1 methodology for the household balance sheet. Therefore, it is completely redundant to require a consolidation of household and business balance sheets, because the household balance already reflects all the value in business balance sheets via its direct and indirect financial claims on them. Z1 recognizes this redundancy, and therefore doesn’t attempt such a consolidation. Accordingly, it is factually misleading to suggest that Z1 doesn’t consolidate in a way that is consistent with MMT consolidation, because Z1 doesn’t consolidate at all. The household lens on economic wealth includes stock market values for business equity rather than financial accounting values on the books of the businesses themselves.

    To recap, and to be accurate and logical, the Z1 presentation is not inconsistent for the reason you suggest, because it doesn’t actually consolidate economy wide balance sheets beyond the household balance sheet at all – it doesn’t NEED to, due to the encompassing nature of household asset claims.

    The corollary to this fact of redundancy should be that one should be very cautious about even attempting such a consolidation, via the use of Z1 balance sheets. The very structure of Z1 balance sheets, given the all encompassing scope of the household balance sheet, suggests that it is not even natural to attempt to do so. This is why Scott and I have been cautioning you about your attempt to relate these Z1 balance sheets to MMT by integrating them in the mismatched accounting way you are want to do.

    I’m going to attempt to do a consistent accounting integration of the Z1 balance sheets. This is where I get to the part where I say, “you’re wrong, but here’s how I would reconstruct your approach in the context of trying to be correct.”

    For simplicity, assume the following conditions about a sample economy, where we examine the relationship between the Z1 accounts and the MMT accounting framework:

    a) No foreign sector; i.e. the economy is either closed, or in perfect external balance
    b) No banking sector
    c) The household sector holds all financial assets directly

    All of these aspects can be modified as desired. These simplifications imply no loss of generality with respect to the primary point under discussion. If you don’t believe that, then we’re done, because I wouldn’t even discuss it further. But for now, here is the explanation of the balance sheet reconciliation:

    I

    Assume the following corporate balance sheet at book value:

    Real assets 20

    Debt 10
    Net worth (equity) 10

    Assume just for this example that there are no market value changes from book; i.e. the market value of stock issued equals 10 as well.

    Under the conditions noted, and supposing government liabilities of 10 held by households as assets, and household real assets of 10, the corresponding household balance sheet is:

    Government Debt 10
    Corporate Debt 10
    Corporate Stock value 10
    Real assets 10

    Net worth (equity) 40

    This is a Z1 type balance sheet for the household sector.

    Again, Z1 says NOTHING about the consolidation of these two balance sheets. It doesn’t have to, because it gives all pertinent information about the economy’s net worth through the household balance sheet. The household’s balance sheet (plus the foreign balance sheet when it’s a factor) incorporates the effect of the business balance sheet directly or indirectly through the financial claims side. Consolidation is not required in order to provide the information that Z1 aims to provide. Because of that, your issue is moot insofar as the purpose of the Z1 presentation is concerned, because you seem to be concerned about financial accounting principles of consolidation when no such consolidation is required. It’s not an issue for the Z1 presentation.

    MMT does say SOMETHING about the IMPLIED consolidation of these two balance sheets, because in this example they form the entire non government sector. MMT says that the only net financial assets held by non government are those liabilities issued by government.

    So let’s attempt a consolidation to demonstrate that. Although Z1 doesn’t do such a consolidation, its easy enough here, because I’ve assumed market values unchanged from book values. Here’s the consolidated household corporate balance sheet:

    Government Debt 10
    Real assets 30

    Net worth (equity) 40

    Corporate debt and equity are eliminated on consolidation. But what you can’t tell is the accounting logic by which I’ve done that. When book equals market, the logical importance of the distinction between the two measures is not apparent on the surface. So it’s easy to “bluff” one’s way through this particular consolidation. You don’t know whether logically I’ve used book, market, or a combination of the two.

    Moreover, the answer to the net financial asset question pops out trivially in this example. Clearly the MMT proposition is at work, as net financial assets equal government liabilities.
     
    II

    Now we come to the harder part. Assume a similar balance sheet set up, but instead assume that while the book value of business equity is 10, the market value of the stock held by households is 20. There is a market value premium to book value of 10. We now have a conventional mismatch between book value and stock market value, as per the normal situation in separate Z1 balance sheets for business and households. I’ve already explained that it is unnecessary to force a consolidation in the context of Z1 balance sheets as they are reported, because Z1 depicts the desired macro value of value entirely through the household balance sheet. Yet MMT requires that we take a consolidated view in order to extract the non government net financial asset position.

    So we attempt to engineer a Z1 consolidation of business and household balance sheets on some sort of logical accounting basis. But we have two different valuation methodologies as per normal financial accounting for corporate balance sheet equity (book) and stocks as assets (market) by households. How do we consolidate balance sheets that employ opposing methodologies without being inconsistent?

    One option might be to use book value for both. That leaves us in the same place as example one. I’ll leave that option for now.

    The other is to force through market values for equity on both. But if we do that, it is critical to acknowledge we are no longer using financial accounting for the business balance sheet. Instead, we are moving into the realm of “management accounting”, which is basically an alternative depiction of accounts for purposes of internal analysis and measurement (The terminology and distinction is legitimate – it is not made up).

    So here’s my management accounting version of a business balance sheet, marked to market:

    Corporate balance sheet at market value:

    Real assets 20
    Equity MV premium 10

    Debt 10
    Stock market value 20

    Before going further, again note that this is NOT standard financial accounting. It is only reasonable for management accounting type purposes such as in this illustration. The equity market value (MV) premium I’ve included never appears in financial accounting for corporate balance sheets, because balance sheet equity isn’t valued according to the stock market in financial accounting. It values it according to the ongoing operations of the firm. The only way to depict such an adjustment from financial accounting to management accounting is to show stock market value as a liability and the equity MV premium as an asset. Of course, it would be entirely wrong from a financial accounting perspective to suggest suddenly that the net worth of the corporation now becomes 20 as a result of the stock market value of its equity. It’s somewhat more reasonable to show it as a management accounting adjustment by way of the stock market value as a liability and the premium as an asset. Again, Z1 avoids this issue entirely by capturing all relevant market value items directly in the household balance sheet. Z1 DOESN’T NEED to do any such management accounting adjustment. All of the balance sheet information that Z1 needs to convey is contained in the household balance sheet, as per my previous explanation.

    In the context of MMT, I would interpret this business balance sheet at market value as follows:

    The business balance sheet now shows an equity liability in terms of stock market value of 20. The balance sheet also includes equity MVP of 10 as a new asset. This reflects the stock market premium valuation over book as an increment to overall asset value, consistent with the adjustment on the liability side.

    From an MMT perspective, the equity liability is a financial liability corresponding to the financial asset that is the stock.

    The entire debate around the question of equity treatment by MMT can now be framed by asking the question as to whether or not the equity MVP asset on this balance sheet in this example is actually a financial asset. IT IS NOT.

    Equity MVP asset is not a financial asset because it does not represent a financial claim. Conversely, stock market value DOES represent the value of a financial claim on the liability side. That’s because it represents the value of the stock as a liability. But there is no such financial asset claim to which equity MVP is linked on the asset side of the balance sheet. What is it linked to? Well, it just represents the present value the market is attaching to the ability of management to generate cash flow from the assets it is managing, over and above the asset value that is recorded on the books. It represents premium value of future cash flow from those assets. But that is not a specific financial asset at all. That premium valuation can’t be sold as an asset on its own. It is embedded in the value of the management of the firm and its assets. MVP capitalizes future cash flows that aren’t otherwise reflected in a specific financial claim. MVP is a “contra asset” whose value reflects the additional asset value in general over book that is implied and attributed to the firm by the stock market.

    Accordingly, the net financial asset position of this balance sheet for MMT purposes is reflected entirely in the stock value liability. It has a net financial liability equal to that stock value.

    Let’s go onto the household balance sheet at market value.

    Household balance sheet at market value:

    Government Debt 10
    Corporate Debt 10
    Stock market value 20
    Real assets 10

    Net worth (equity) 50

    This balance sheet is unchanged from earlier. This is the prototype Z1 presentation. It already contains all the information you need to get a market valued view of the economy.

    Finally, at long last, here’s the consolidated household / corporate balance sheet at market:

    Government Debt 10
    Real assets 30
    Equity MV premium 10

    Net worth (equity) 50

    Again, this is NOT a standard financial accounting presentation. Z1 DOESN’T NEED to do this consolidation in order to present the value in the economy as it shows up in the household sector alone. I’ve only done this for MMT management accounting and illustration purposes. Consolidation eliminates debt and stock market value. The equity MV premium remains as an asset. Net worth on consolidation is the same as net worth of the household sector, which again is why Z1 presents only the household sector. As per my reasoning about, the equity market value premium of 10 that shows up as an asset in the consolidation is NOT a financial asset, because it does not represent a financial claim. It only represents the market’s implied premium valuation of assets over book value. It represents the market’s capitalization of future cash flows from existing assets that are not otherwise represented as real asset book value or by some specific financial claim.

    Accordingly, the net financial asset position of the now consolidated non government sector is equal to the government liability of 10.

    QED

    But beyond this demonstration of logical accounting congruence, it is just unproductive to muddy the straightforward analytical idea of MMT net financial assets by attempting to drag something else into the mix as random as stock market valuation. Do you really think MMT analysts completely ignore the behaviour of stock markets in assessing fiscal policy or any other policies? Do they deliberately and foolishly ignore it so that it must be dragged explicitly into “the model” in order to ensure they think about it? Does one actually believe MMT advocates think about nothing else by way of economic data inputs other than their macro level sector financial balance equation? Scott’s series of comments here should clear that up. And MMT writings strongly suggest some thoughtfulness in this regard. MMT has much closer ties to Minsky than the neoclassicals, for example. In addition to other advantageous links of MMT to reality, that should tell you a lot right there if you know about Minsky and the stock market. MMT’ers can walk and chew gum at the same time, and do so reasonably well.

    But your very specific issue here about equity comes down to this: is it useful to classify the difference between the book value of equity and the market value of the corresponding stock as a “net financial asset”. The unambiguous answer is no. As per my final accounting demonstration, it is incorrect in that it fails to distinguish between a financial claim and the present value of cash flows that are otherwise unrepresented as a financial claim. And it is unnecessarily and dysfunctionally confusing, given the explicit purpose of MMT in adopting that NFA (net financial asset) terminology to apply to the effect of government deficits in responding to the demand for net saving.

    In conclusion, the MMT concept of NFA has full integrity as is. It is central to MMT accounting analysis and policy formulation, which is quite capable of using stock market values as one of many different economic inputs in assessing prospects for aggregate demand and the appropriate MMT NFA policy response. Both financial accounting and the management accounting used here distinguish properly between MMT NFA and stock market valuation effects accordingly.

  89. Scott & JKH,

    Thank you for your responses. I plan to respond but it may take me a day or two.

  90. Hi Scott,

    “what I’ve said above has been my interpretation of all this going back to the late 1990s, actually, for what it’s worth.”

    It was very worthwhile, thank you!

    In the link you previously provided, your walk-through of the 1990s economy via the sector financial balances model makes a lot of sense. As I understand it, you are referencing the private sector’s “new economy” boom and unsustainable dis-saving as its own phenomenon, driven by the private sector itself, and suggesting it just happened to occur on the heels of government efforts to reduce the deficit (such as raising top marginal tax brackets). This aligns very well with my sense of things (again, hoping I am not misrepresenting you).

    However, with respect to “surpluses caused the recession” being equivalent to “stock bubble and unsustainable private sector dis-saving caused the recession”… let’s just say if I was contemplating signing up at a new doctor’s office that everyone was buzzing about and they showed me their patient case studies, and said “notice how in this case the patient’s stomach pains caused them to have food poisoning illness”… well, I might question their credibility! (i.e., symptoms do not cause consequences, the actual underlying causes do). There are other things than tainted food that can cause stomach pain, and there are other things than automatic stabilizers that can cause government budget surpluses (i.e., active changes in policy, but as I understand it, not much of that occurred after 1993, six years prior to the surplus).

    I’ve taken a quick look at some of Randall Wray’s 1990s publications as you suggested, and I have mixed reactions. He makes statements like “Even more important, our economy cannot continue to grow robustly as the government sucks disposable income and wealth from the private sector by running surpluses” which I rightly or wrongly judge to be misleading. (It depends on how you define “continue” and “robustly” and it doesn’t mention the private sector over-consumption and stock bubble dynamics that were on a much larger scale than the amount of wealth being sucked out by government). But then in the same piece he also says: “Movements of the budget position are largely automatic. Rapid economic growth, such as that experienced in the United States since 1992 or in Japan previous to 1990, tends to cause tax revenues to rise faster than government spending, resulting in surpluses.” Which is in closer alignment to the viewpoint you and I have just discussed. So overall, combined with some of Bill’s statements such as “Bush’s deficits followed the sabotage of the Clinton surpluses, which drove the US economy into recession in 2001”, I am still left thinking there is a “branch” of MMT with whose emphasis I (so far) still find it difficult to agree with…

    I didn’t expect this thread to turn this lengthy, but I appreciate the commitment of you and other commenters to helping newcomers. As I’ve said several times, I really think the MMT cause would benefit from a wiki and an FAQ, even if they just categorized a set of links to relevant blog posts. Then some replies to questions like mine would be much easier to answer. With Bill’s productivity, I imagine he could have both complete in a month if he just worked on it instead of a blog post one day a week 🙂

    Anyway, I’m feeling good about the outcome of this discussion… I will toast you in absentia next time I have a beer!

    [Reply to JKH coming later].

  91. Scott,

    I’m late/slow in picking up on several points you’ve been making on this thread. I’ve never thought much about the specific policy point hbl is getting at with the Clinton surpluses. My assumption has simply been that the US consumer’s desire to dissave in the process of an asset bubble showed up in both the current account deficit and fiscal surpluses. If you’ve covered this already, I apologize. But while I can see where the desire to dissave was a powder keg for private sector balance sheets, what should have been the fiscal policy response roughly while this situation was developing?

  92. Hi JKH,

    The general MMT approach to the late 1990s is the following:

    1. a job guarantee, since even with strong AD, there still were many left behind, and had the policy been in place earlier, it would have been a strong automatic stabilizer, as I demonstrated in my simulations of the policy. Note that the problem during the late 1990s wasn’t the automatic stabilizers per se, but rather the asset price bubble that drove the automatic stabilizers. MMT’ers are in favor of strong automatic stabilizers in general, and I’ve noted some additional thoughts I have on these beyond even the job guarantee on Warren’s blog (though the job guarantee is certainly the heart and soul of the MMT countercyclical policy proposals).

    2. asset price bubbles should not be dealt with through active use of traditional macro policy levers (raise interest rates, in particular), but rather through more effective financial regulation. In the case of the late 1990s, this could have been done via several measures, such as proactively raising margin requirements, a more effective SEC (particularly duirng the period in question; Bill Black would prefer there be criminologists involved, not just financial/legal analysts, for instance), and the sort of regulation of the credit system that Bill has proposed here on numerous occasions. Some MMT’ers also propose procyclical adjustment of bank capital requirements. You might look at the papers by Eric Tymoigne and Jan Kregel from 2008-2009 at levy.org on regulation.

    3. a lot of MMT attention was given during the late 1990s to attempting to alert others about the impending financial collapse brought about by the unprecedented decline in the private sector financial balance. This was in my view mostly driven by the stock market bubble, as proactive fiscal austerity to reduce deficits doesn’t stimulate AD the way we saw then. Thus, the proactive attempts to cut deficits by Congress, Bush I, and Clinton were of far less importance. The problem a good deal of MMT research was dealing with here, though, is the pervasive view at the time that the surpluses were a good thing and should be allowed to continue well into the future. MMT’ers were shouting out to anyone who would listen that they weren’t good (they were a consequence of substantial financial instability driven by an asset price bubble), they wouldn’t continue (there would be strong turnaround once the desire to leverage reversed), and their needed to be a strong policy response to allow big deficits as soon as the private sector decided to net save instead of net dissave. There was a good deal of concern that policymakers would try to maintain surpluses even once the economy slowed.

    Best,
    Scott

  93. Hi HBL,

    Just one thing . . . I would simply say that any MMT’er looking at the sector financial balances and seeing that there was a strong reduction in net saving in the non-govt sector wouldn’t be a very good economist if he/she stopped there. He/she would have to go find out how and why this was happening. The fact of the matter is that the stock market bubble and the budget surpluses were two sides of the same coin in understanding the reduced net saving of the private sector. That’s what I meant when I said they were “equivalent.” I didn’t mean to suggest whatsoever that whenever you see a budget surplus you also have a stock market bubble (or whatever else you might have meant by your analogy). Thus, I don’t think your doctor/patient analogy has much application at all to our approach. As JKH noted, we “can walk and chew gum at the same time.” You seem to be assuming a rigidity and narrowness of analysis we would never advocate, to an almost silly degree–in other words, it’s so obvious to us NOT to make the mistakes you’re worried we’ll make, that that’s perhaps why you find we haven’t discussed it much.

    One should also recognize that during the late 1990s, MMT’ers were (like the 2000s) a minority pointing out that things weren’t as rosy as everyone suspected, and the financial balances approach was at the center of that realization. If anything, there were fewer people willing to suggest anything was wrong then compared to the 2000s, as unlike the 2000s, the late 1990s were accompanied by low/falling inflation, rising measured productivity, and budget surpluses (which means a lot of people who do rather simple–and generally incorrect—analysis tend not to see any problems). Indeed, it was fashionable at the time to suggest the business cycle had been conquered. This all seemed like “Goldilox” to most, and MMT’ers were a very small minority recognizing this wasn’t the case. Randy even wrote a few pieces directly attacking the “Goldilox” vew. So, to repeat, overall and quite contraty to your concerns that we will miss something important because of the sector balances approach, we were among the very few speaking out that there were big problems building.

    Someday we’ll have to have that beer(s).

    Best,
    Scott

  94. JKH,

    First, thanks for your highly detailed response.

    Second, I’d like to briefly try to defend my motivations here. You spend a paragraph admonishing me for questioning the ability of MMTers to consider external-to-the-model factors such as stock markets. But as I’ve outlined in recent comments above, I have been genuinely baffled for months as to why every mention of the 1990s surpluses by MMT authors that I came across seemed to be explicitly blaming the government surplus as the causative force for both the subsequent recession and the private sector’s decision to leverage up. And in that period, not one of those posts I read (perhaps my sampling was just bad luck) came with a link to further more nuanced details on that claim, despite it being outside the mainstream world view of most people unfamiliar with MMT. Other “unconventional” claims were generally given detailed discussion. And given that I am a relative MMT-newcomer, just because I am convinced MMTers have many very important things right, do I have to automatically take it on faith that they have everything right, without evidence? So it seemed natural to me to wonder whether, given the emphasis in so many MMT posts that the non-government sector can’t change its net financial assets, could that be a reason that some behavioral dynamics within the private sector were possibly being given insufficient emphasis? I had done some searches across Bill’s blog without finding answers, but unfortunately hadn’t gone researching on other sites yet. Since this thread started, I have now become very clear on the fact that MMTers DO consider these things.

    Third, before I respond to some elements of your post, I want to be more explicit about what my previous questions were trying to accomplish. Imagine these three models:

    [MODEL A] — The MMT sectoral balance sheet accounting model in which the non-government’s net financial assets are exclusively claims on government.

    [MODEL B] — What I had called the “real world” accounting model, but perhaps that was a poor choice of term. Think of this as what you would get if you asked an experienced accountant who had never been exposed to MMT, “Given these sectoral balance sheets, please calculate the net balance sheet equity of the entire economy,” and you then subtracted the value of the tangible assets.

    [MODEL C] — The model you would come up with if I said, “You can use only one model as a window onto the economy’s macroeconomic balance sheets. Please design one that gives you the most useful possible such window.” This is what I meant in previous comments by questioning whether the MMT model reflects “the thinking (and therefore behavior) of participants in said real world (corporate decision makers, stock holders, etc)”.

    For me, THE biggest source of confusion in this discussion has been which of these three models each of us considers equivalent (e.g., A = B = C, or A = B != C, etc, where ‘!=’ means ‘not equal to’ for anyone unfamiliar with the symbols).

    I entered the discussion under the impression that [MODEL B] and [MODEL C] would be similar to each other, possibly even identical, and that [MODEL A] would be very distinct from the other two. And most of my questions around “real world” accounting were trying to get at what [MODEL B] would look like. You usually responded that my propositions would be “incoherent”, “illogical”, etc, but I could never quite tell whether you thought that true under all three models. It was obvious to me what I was suggesting was incoherent under [MODEL A]. Of course if you consider all three models equivalent, then my suggestions were incoherent PERIOD, and I have reached the level of accounting knowledge titled “knows just enough to be dangerous” 🙂 !

    I’m going to have to respond in two parts, but hopefully this will help frame my follow-up comment where I’ll selectively respond to a few of your points.

  95. JKH,

    Part two… I had a list of quotes I wanted to respond to but I’m going to skip most of them to keep this shorter, as this has taken enough of your time already.

    “it is equally illogical to suggest that a “net financial asset” has been created simply due to the difference between corporate book value and the value of a stock held by a household.”

    Agreed, this is illogical in the MMT [MODEL A] accounting. What about [MODEL B]? (If you don’t choose to answer these you can just treat them as rhetorical questions). Perhaps the issue is the term “net financial asset” has special meaning to MMT. If we called it “net assets”, would [MODEL B] show an increase in the consolidated balance sheet as the market value of the stock went up?

    “The reason that it is wrong is that Z1 doesn’t consolidate corporate and household balance sheets AT ALL. The reason it doesn’t is that it doesn’t NEED to. To do so would be completely redundant.”

    The Z1 initially entered the discussion as an example of where one might find an example of accounting approaches used by non MMTers (it was also introduced as such in the section of the Godley/Lavoie book I was quoting from). You are correct that I did “go looking for financial liabilities directly on the equity portion of corporate balance sheets” and didn’t find them there. My initial goal by looking was to help in determining whether [MODEL A] equals [MODEL B]. But thank you for the walk-through.

    “The corollary to this fact of redundancy should be that one should be very cautious about even attempting such a consolidation, via the use of Z1 balance sheets. The very structure of Z1 balance sheets, given the all encompassing scope of the household balance sheet, suggests that it is not even natural to attempt to do so. “

    Does Japan’s consolidated national accounts data add anything to this discussion? Shares are listed under assets and liabilities. The liability side is always larger (and the gaps grows over the years), but the difference between values on the asset and liability sides only ranges from about 5%-30%. So I’m not sure if it’s measurement error or an amazingly fluid difference year-to-year between market and book value. Or some other explanation.

    “The other is to force through market values for equity on both. But if we do that, it is critical to acknowledge we are no longer using financial accounting for the business balance sheet. Instead, we are moving into the realm of “management accounting”, which is basically an alternative depiction of accounts for purposes of internal analysis and measurement…”

    Thank you for this illustration. Mixing management accounting (oriented toward internal analysis) and financial accounting in consolidating macroeconomic sectors seems to my naive mind like a strange thing to do, but I see how it nicely balances out the MMT accounting, at the very least.

    I thought about running through some balance sheet examples of what alternative measures of total balance sheet equity might look like and why, but it’s probably best for me to wrap up here, and you can probably predict what I might try to do anyway. The question I would have ended up asking would have been “and why is the MMT approach better than this approach?” but we don’t need to go there, and I do trust there are some very good answers that would come forth.

    From the overall discussion thread I am satisfied that MMTers conduct high quality broad analysis on relevant dynamics within sectors that go beyond their basic models. Therefore whether or not their core balance sheet model captures changes in market values and some other horizontal operations explicitly in the aggregate seems less important than it did.

    Thanks to JKH and other participants.

  96. hbl,

    Just guessing – foreigners could be holding Japanese shares. Not familiar with the Japanese equivalent of Z.1 . . .

  97. That seems like a good guess, Ramanan!

    I subtracted “of which shares” from “shares and other equities” on both the asset and liability side to arrive at what I presume are equity positions in un-incorporated and/or non-publicly-traded businesses… and they match perfectly on the asset and liability side. I’m not sure whether that is conclusive of anything as I presume there would be no market value available for these businesses, but it does seem likely to me that your guess is correct, which given the closeness between the asset and liability numbers would be suggestive that [MODEL A] = [MODEL B] at least with respect to Japan’s national accountants. (Just guessing, myself, though).

  98. Scott,

    Thanks – makes sense – JG and regulation should have been in place; given their absence, preparedness was required for the bubble burst and inevitable fiscal deficit response.

    Regulation should have mitigated the bubble, tempered the concurrent boom and surplus, and moderated the subsequent deficit requirement. (Horizontal) regulation makes sense to me as a complement to the core MMT sector balances model.

    hbl (4:17),

    Sorry. That particular “admonishment” paragraph was bad writing. I actually intended “you” in the more general sense. (My opening paragraph salvo on Z1 interpretation was pointed however, but probably poor form as well.)

    Your motivation observation may be fair. But again I think Scott just demonstrated the walk/chew combo with respect to sector financial balances et al. In fact I think I demonstrated the idea myself just by asking the question. I had completely separated the two components in my mind, to the point that I didn’t get around to asking a specific question about policy I’d been pondering, until after responding to you.

    Still, I can see your motivation in general. It might be appealing for MMT to have a horizontal “plug-in” or “add-on” to the vertically oriented sector financial balances model. But I’d be looking for proof of stumbling when chewing, rather than assuming such proof in condemning the absence of a more formal chewing model that complements the core walking one.

    I don’t want to pre-judge your A, B, C model hierarchy. Just bear in mind that the sector financial balances model is derived from the national accounts model. The NA model is a flow model. Z1 is a reasonable choice as a corresponding stock model. I think I’ve written enough at length to show that these things all commute with each other in terms of structural transformation. They are all consistent.

    So it’s a false choice to suggest one must pick a single model from the group and exclude the others. Basically, SFB assumes the existence of NA and Z1. You certainly don’t have to exclude admission to horizontal detail merely because you choose SFB with vertical insights as your core operating model.

  100. Dear HBL, JKH and Scott and all

    The reference to the Clinton surpluses is as HBL constructs it. Scott has explained our concerns at the time. If you go back into the literature you will find that the mainstream thought these surpluses were an excellent demonstration of fiscal prudence. The reality was that with external deficits, the US private domestic sector had to continue financing the spending which pushed the dotcom boom over the edge by increasing indebtedness given the fiscal stance.

    The Clinton surpluses while a product of the boom were also causative in the sense that they increasingly squeezed the private domestic sector of liquidity. Given the other distributional pressures that were going on in the private domestic sector a bust was inevitable.

    So as I argued in The origins of the economic crisis there were other neo-liberal developments that were associated with the build up before the crisis. The increasing gap between real wages growth (virtually zero) and labour productivity (strong) meant that capital were able to extract increasing amounts of real output and this not only provided the largesse for speculative ventures but also presented them with a “realisation” problem – how will the workers buy the increasing output if we are squeezing them in terms of real wages.

    Enter – the financial engineers who saw that the workers could continue consuming if they borrowed more. So capital (as a sector) not only were able to extract proportionally more real output but could also get a nice interest return on the debt.

    Taken together the strategy could never be sustained and with the asset price boom bursting the fiscal drag coming from the pursuit of the surpluses quickly pushed the US economy into recession.

    Further, the real economy in the US did not grow during the 1990s at rates that were out of kilter with previous recoveries. The growth was reasonable by historical standards but not outstanding. There were also harsh changes to welfare policies that Clinton enacted in the spirit of the OECD Jobs Study. So my view was that they could have easily used tax policy to choke the asset price boom while directing net spending towards workers and welfare recipients which would have increased real output and job creation in productive sectors and reduced the pressure to increase private debt coming from the distributional squeeze.

    best wishes
    bill

  101. hbl 5:39,

    We can wrap it up then.

    Hbl, you have a lot of insights that MMT’ers would be better off considering than not.

    That’s not being patronizing. You might be surprised to know that my early exchanges with Scott and Bill were exhibits of thorn. More than that, I still have a few criticisms on the back burner related to the presentation of the analytical framework. I’d like to become more comfortable with policy application before making any sort of issue of them. But that’s indicative of a natural resistance of newcomers to MMT. Presentation is important.

    My personal preference might be to present the entire subject analytically as an explicit portfolio of models, rather than the sector financial balances model quite so up front, center, and relatively naked. I’d prefer to see more commutation between national income accounts and national balance sheet accounts as a matter of course.

    I haven’t looked at the Japanese accounts yet, but I know the Canadian ones are structured differently than Z1. Going back to your specific point on equities, I think the important thing is to be able to identify both the substance and economic importance of equity market changes, alongside the substance and policy importance of the net saving effects of deficits. They are separate but connected, and the accounting presentation should be in synch with this.

    Thanks for a very worthwhile discussion/exchange.

  102. …So as I argued in The origins of the economic crisis there were other neo-liberal developments that were associated with the build up before the crisis. The increasing gap between real wages growth (virtually zero) and labour productivity (strong) meant that capital were able to extract increasing amounts of real output and this not only provided the largesse for speculative ventures but also presented them with a “realisation” problem – how will the workers buy the increasing output if we are squeezing them in terms of real wages…

    Would it be correct to say that during asset / stock market bubbles it is more difficult to rearrange the imbalances between the horizontal and vertical components of an economy, because without tighter regulation to offset, a net expansion of government spending quickly results in inflation etc? This seems to be a point that hbl makes throughout, that during downturns, fiscal expansion can easily be used alone as a reactionary policy, whereas during near full employment / booms, a proactive stance must always be accompanied by regulatory measures to not have negative effects. So, instead of saying that the Clinton surpluses caused the subsequent downturn, it was the failure of the administration to see to it that growth was accompanied by net asset growth and not excessive levering that led to the instability of the situation if not to the boom itself?

    Which raises the question of whether there is such a thing as a stable boom? How does MMT assess which parts of economic activity are ‘healthy’ growth / contraction and which parts are ‘unhealthy’ (if there is such a distinction)? How does filling the output gap during downturns distinguish (in theory and in practise) between ‘good’ and ‘bad’ liquidation (again, if there is such a thing)? If on imagines that tighter regulation manages to iron out private credit cycles, am I correct in assuming that public deficits must completely fill the gap (i.e. permanently high deficits) to keep activity going or can real output levels be held constant with smaller gross balance sheets?

    A bunch of question, I know – hopefully not too revealing of my economic illiteracy…

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